David Asmoucha v. Minister of National Revenue, [1986] 1 CTC 2383, [1986] DTC 1299

Bonner, T.C.J.:—This is an appeal from an assessment of income tax for the 1982 taxation year. On assessment the respondent disallowed a deduction of $3,834.27 claimed as interest on borrowed money used to earn interest income. The sole issue in this appeal is whether the respondent was right in doing so.

At all relevant times the appellant was one of three shareholders of a company known as Pollock Import Co. of Vancouver Ltd. (hereinafter "Pollock”). In 1981 and 1982 Pollock owed money to its three shareholders. It appears that the shareholdings were divided equally among the three, but that the amounts of money owed to them were unequal. Pollock's cash flow did not permit repayment. Accordingly, it was decided that the company would pay interest.

The interest expense which the appellant seeks to deduct and which is said to be the cost of earning the interest paid to the appellant by Pollock was the amount paid by the appellant during 1982 on a mortgage. The mortgage loan was made to the appellant by the Royal Trust Company in 1974. The money borrowed by the appellant was used, at least initially, to pay for the purchase of a house for use as his residence. The indebtedness to Royal Trust continued to exist, at least until the end of 1982. The appellant still resides in the house. Throughout 1982 the amount of Pollock’s indebtedness to the appellant exceeded the amount of the appellant’s indebtedness to Royal Trust.

The appellant can succeed in this appeal only if he can bring himself within subparagraph 20(1 )(c)(i) of the Income Tax Act. In Canada Safeway Limited v. M.N.R., [1957] C.T.C. 335 at 344; 57 D.T.C. 1239 at 1244, Rand, J. pointed out that:

It is important to remember that in the absence of an express statutory allowance, interest payable on capital indebtedness is not deductible as an income expense.

Subparagraph 20(1 )(c)(i) reads as follows:

20(1) 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 may reasonably be regarded as applicable thereto:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his 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)

The appellant’s representative argued:

. . . that Pollock Import Co. of Vancouver Ltd. gives David Asmoucha his living, so whatever money he puts in there enables him to earn the income from there. And David Asmoucha is not a controlling shareholder in the company and he does not have the final say.

So, when he put the money in the company and he started interest from 1981 and he wanted to put that money into his house to clear off the mortgage he could not do so. So, whatever interest he was earning from that particular money was preventing him from paying off his house, or the expense against the house was a direct expense for that income and, in fact, one of his partners did the same thing, but his partner’s case was different because he had a smaller mortgage and he borrowed some more money to put into Pollock and he was allowed a deduction.

The case was the same except that in his case he had some cash in hand. When the Respondent said that some of the money was not cash in the company, it was dividends or salaries or whatever prevented from him — coming to him, it is the same thing because it is his income prevented, like, you know, if the income came to him it would enable him to pay off his mortgage.

This argument cannot succeed. The right to a deduction under subparagraph 20(1 )(c)(i) rests on the use made of the borrowed money and not on the use that would have been made if circumstances had been different. The mortgage loan made when the house was purchased was not repaid. No part of the indebtedness of Pollock to the appellant was shown to have arisen from money borrowed from Royal Trust and reloaned to the company.

In Canada Safeway, (supra, at 345 (D.T.C. 1244)) the Supreme Court of Canada considered a contention that borrowed money spent by the borrower on the acquisition of the capital stock of another company had, within the meaning of a predecessor of subparagraph 20(1)(c)(i), been "used" not for the purpose of earning dividend income but, rather, to secure other benefits which flowed from control of the new subsidiary. Rand, J. rejected that contention and stated:

What is aimed at by the section is an employment of the borrowed funds immediately within the company’s business and not one that effects its purpose in such an indirect and remote manner.

In Joel Sternthal v. The Queen, [1974] C.T.C. 851; 74 D.T.C. 6646 an argument was made which was remarkably similar to that advanced here. The taxpayer in that case borrowed money which he then reloaned, interest- free, to his children. Counsel contended that the taxpayer held interestbearing assests far in excess of his liabilities and thus might have sold the assets, loaned the proceeds of the sale to the children and replaced the assets using borrowed money, with the result that interest costs would be deductible. The taxpayer argued that the “fundamental use" of the money was determinative. In rejecting this argument Kerr, J. stated at 856 (D.T.C. 6649):

On the contrary, my appreciation of the facts is that the money was borrowed and used by the plaintiff for the purpose of making non-interest bearing loans to his children, not for the purpose of earning income. He chose to find the money for the loans by borrowing, and the fundamental purpose of the borrowing was to make the loans.

A case such as the present must be distinguished from one involving a trust which, as was noted by the Federal Court of Appeal in Phyllis Barbara Bronfman Trust v. The Queen, [1983] C.T.C. 253 at 255; 83 D.T.C. 5243 at 5245:

. . . has no purpose and the trustees have no purpose save to hold trust property, to earn income therefrom and to deal with such income and the capital of the trust in accordance with the provisions of the trust instrument.

For the foregoing reasons the appeal will be dismissed.

Appeal dismissed.