Dimitr Jordanov, Anna Jordanov v. Minister of National Revenue, [1986] 1 CTC 2183, 86 DTC 1136

Kempo, T.C.J.:—The appellants, Dimitr and Anna Jordanov, are husband and wife. Upon application by their counsel, their appeals were heard on common evidence in that the years under appeal and the issues were identical.

The appellants’ contest as to the calculation of the capital cost allowance of the Ross Street property for each of the 1978, 1979 and 1980 taxation years is abandoned by their admission, through their counsel, that the Minister's calculation as detailed in paragraph 5(h) of his reply to notice of appeal, filed, are correct. Accordingly the appeals in this respect are dismissed.

Issue

The remaining and sole issue in these appeals is as to the deductibility, in 1978, 1979 and 1980, of interest on borrowed funds secured by mortgage taken out in March 1978 on 167-169 Ross Street, St. Thomas, Ontario (the “Ross Street" property) owned jointly by the appellants. In 1978 approximately one-half of the Ross Street property (the second storey) had been used by the Jordanovs as their principal residence; the balance having been used by their partnership to earn both rental income and business income from their denture clinic. In early 1979, as another residence was acquired by them, the residential portion was thereafter converted to business or rental use.

On reassessment the Minister disallowed interest expense in the amounts of $620.46, $424.03 and $405.12 in the 1978, 1979 and 1980 taxation years respectively as to each appellant herein on the basis that these amounts represented interest on that portion of the borrowed funds which had not been used for the purpose of earning income from a business or property but rather were amounts of interest paid on borrowed money used for personal purposes, i.e., to acquire a new principal residence. Paragraphs 18(1)(a), 18(1 )(h) and 20(1 )(c) of the Income Tax Act (the "Act") are in play.

The appellants’ position is that all of the borrowed money had been used in the business of the partnership, that the disputed portion of the borrowed funds had been used to make a contribution of capital to the business and that they simply drew down on their partnership capital, the effect of which was the retention of the residential portion of the Ross Street property in the business rather than being sold. The appellants assert that given this scenario it is immaterial, for fiscal purposes, what they thereafter did with the disputed amounts and that interest on the entire borrowed funds is deductible.

Decision

For the reasons given, the appeals of each of the appellants for their respective 1978, 1979 and 1980 taxation years are dismissed.

Reasons for Decision

Facts

The appellants are equal partners in the Homedale Denture Clinic. The Ross Street property had been jointly acquired by them late in the year of 1974 as a rental and business-use property. Following renovations, the main floor was used as a denture clinic and the upper floor was rented. Because the tenants were unsatisfactory and causing damage, the appellants took possession of the upper floor for their own residence approximately one year later, in late 1975.

In March of 1978 the vendor's mortgage on the Ross Street property then amounting to approximately $10,000 became due. In order to have extra money available at a low interest rate for possible future renovations the appellants borrowed $25,000 on the security of the property. In or about this time frame they had already become disenchanted with living at the business premises and were looking at other residential property. In the summer of 1978 they jointly acquired, renovated and rented out property at 60 Hinks Street (the “Hinks Street” property) which they sold at a gain in or about October of that year. They then acquired new residential premises and vacated the top floor of the Ross Street property either in December of 1978 or January/February of 1979.

The appellant, Anna Jordanov, was not present at the hearing. Dimitr Jordanov did give evidence. He is an electrician by trade but described himself as running the denture business with his wife. I have no reason to believe that the business was other than a successful one. However, Mr. Jordanov's testimony reveals that he was markedly unsophisticated in accounting and taxation matters and that he conducted all of his business and rental activities in a very simplistic and straightforward way.

The denture clinic was operated in the name of the Homedale Denture Clinic in 1978 and 1979. There is evidence of only two bank accounts. One was a current account (name undisclosed) which was conceded to have been a business account. The other was an interest-bearing savings account in the name of “A. D. Jordanov.” The appellants had given the bank written authorization to draw on this savings account as the occasion arose in order to cover any shortfalls arising in the current account.

I now return to the $25,000 borrowing. The sum of $10,221.65 was disbursed in discharging the vendor's existing mortgage and the remaining amount, $14,778.35, was deposited into the savings account on March 31, 1978. Of and from that amount it was determined and conceded by the respondent that from the date of deposit to December 1, 1978 the sum of $6,800 had been used by the appellants to earn income from their business. As stated earlier it was the respondent's position that the balance then remaining, $7,978.35, had not been so used but rather had been withdrawn and used by the appellants on or about December 13, 1978 for the acquisition of their new principal residence.

Exhibits R-1 and R-4 establish the following relevant transactions in respect of the savings account:

EXHIBIT R-1

A. D. JORDANOV

SAVINGS ACCOUNT

	Withdrawal Deposit	Balance
December 1977		$	104.14
A. March 31/78	$14,778.35
B. March 31/78 to
December 1/78	$ 6,800.00
C. Oct. 31/78	$17,114.42
Interest —
Apr. 29/78 to
Oct. 31/78	$ 451.84 $25,544.61
D. Dec. 13/78	$25,000.00
Oct. 1980		$	407.58
	EXHIBIT R-4
	NOTES

A. Proceeds from $25,000.00 mortgage on Ross Street property less $10,221.65 pay off of prior mortgage held on Ross Street property.

B. Amounts transferred from personal savings account to personal chequing account. Amounts used in the partnership.

C. Proceeds from sale of Hinks property.

D. Amounts withdrawn and used to purchase Appellants’ personal residence.

Item #B in Exhibit R-4, supra, is disputed by the appellants as to the word “personal” appearing before the words “savings account”. Mr. Jordanov testified that he had always thought the savings account was his business account too. When asked why, he said it was because he had signed the bank transfer of funds authorization previously mentioned. He was not able to explain why, in filing his tax returns, he personally declared all of the interest in this account nor why he deposited the Hinks sale proceeds therein. As noted earlier the current account was the business account.

The appellants had used the accounting services of Mr. Ernest A. Manchester continuously since 1973. Mr. Manchester testified that he rendered advice to them when asked, and that his main function prior to 1978 was in the preparation of annual statements and the tax returns in respect of their business and personal matters from the information supplied by them. He had prepared a balance sheet of the business to reflect a capital or partnership account for the first time for its 1978 taxation year. He also confirmed that the residential use of the Ross Street property had been designated for tax purposes as the appellants’ principal residence and that on conversion to business or rental use he added $15,000 to the partnership capital account for its 1979 taxation year to reflect its increase in value between 1975 and 1979. He acknowledged that as no capital account had been maintained prior to 1978, no capital cost adjustment would have been recorded in 1975. He said that through negotiations with the Minister's auditor the $15,000 value amount had been reduced to $7,200.

Mr. R. J. Wiseman is a field auditor employed by Revenue Canada, Taxation. He testified that the reassessments in issue were made in accordance with the factors as outlined hereafter in Exhibit R-5:

EXHIBIT R-5

Calculation of Personal Portion

1978

a) — half of Ross Street property used as personal residence.

— half of $10,221.65 pay off of prior mortgage in respect of personal portion of property.

b) — $7,978.35 of $14,778.35 proceeds of mortgage not used in the business in the year and remained in savings account.

$10,221.65 : 2 2= $ 5,110.63

+ 7,978.35

$13,089.18

Therefore interest on $13,089.18 disallowed as a deduction from income.

1979 & 1980

In 1980 the whole of the Ross Street property was used in the business.

$7,978.35 remained in the savings account until December 13, 1978 when it was used to acquire the Appellants’ personal residence.

Therefore interest on $7,978.35 disallowed as a deduction from income.

Mr. Wiseman was of the opinion that, providing the partnership capital account did not reflect the 1975 adjustment for principal residence use of the Ross Street property, a withdrawal of capital by the appellants from their partnership capital account in 1978 would have left it in a negative position. However he also conceded that this would not have brought about any immediate fiscal consequences, that the ability of the business to continue would not have necessarily been impaired thereby and that the change of use of the residential part of the Ross Street property from a principal residence use to a business or rental property use would have resulted in a capital contribution by the appellants to their business.

Analysis

On the evidence I am unable to conclude that any part of the $25,500 drawn from the savings account on December 13, 1978 comprised of borrowed moneys that were used to earn income from a business or property as is required for the appellants to come within paragraph 20(1)(c) of the Act.

That the appellants intended at the time of borrowing to use the surplus of $14,778.35 in the business, and in fact so used $6,800 of it, does not establish that the remaining $7,978.35 was so used in fact. And further that the latter amount remained in the savings account to December 1978, and could have been used as working capital through a transfer of funds, does not establish that it was so used. There are evidentiary factors which point away from the savings account being anything more than a joint personal savings account and that the surplus borrowed moneys of $7,978.35 therein being more than just surplus funds when it was finally used by the appellants in December 1978 to acquire another principal residence. This account had not been shown as an asset in the financial statements of the business, and the interest earned therein had been declared as the sole personal income of Mr. Jordanov. Further, the Hinks Street property was admittedly not an asset of the business and its sale proceeds, which belonged jointly to the appellants, became intermingled with the funds in the savings account in October of 1978.

Counsel for the Jordanovs made a very eloquent submission that from the appellants’ point of view it would be reasonable to infer that as they would be aware that they were contributing 50 per cent of the Ross Street property back to the business they would logically take back the $7,978.35 surplus of the borrowed money which they would have viewed as being Capital.

As noted earlier, Mr. Jordanov took a very simplistic attitude and approach to his business and personal affairs. There is nothing in the evidence which leads me to believe, or which would support a reasonable inference that at any material time he knew what a capital partnership account was, let alone that he had made a conscious business decision in December of 1978 to draw down on it and nothing else so as to enable his business to retain the vacated part of the Ross Street property to earn income therefrom. Ast stated by R. St-Onge (as he then was) in Manfred Holmann v. M.N.R., [1979] C.T.C. 2653 at 2653; 79 D.T.C. 594 at 595 (T.R.B.) and reiterated by Judge Brulé in Colin C. Mills v. M.N.R., [1985] 2 C.T.C. 2334 at 2335; 85 D.T.C. 632 at 633 (T.C.C.) :

. .. the Board should not examine what the appellant could have done with the money but what he did.

In the case at bar there was borrowed money sitting in a personal savings account which was used to purchase another residence and it was not used to earn income from business or property as is required in paragraph 20(1 )(c) of the Act.

Having decided this case for the reasons aforesaid, it is not necessary to deal with counsels’ submissions and arguments in respect of the principles and their applicability to the case at bar arising out of the cases of TransPrairie Pipelines Ltd. v. M.N.R., [1970] C.T.C. 537; 70 D.T.C. 6351 (Ex. Ct.) and Phyllis Barbara Bronfman Trust v. The Queen, [1983] C.T.C. 253; 83 D.T.C. 5243 (F.C.A.). Trans-Prairie involved a scheme of business expansion through a reorganization and payout of capital and Phyllis Barbara Bronfman Trust involved allocations of capital to a beneficiary of a trust via funds borrowed specifically for that purpose.

In conclusion, I am unable to find that the Minister was in error in assessing the appellants as he did for their 1978, 1979 and 1980 taxation years and therefore the appeals are dismissed.

Appeals dismissed.