The Laurentian Club Incorporated v. Minister of National Revenue, [1982] CTC 2299, 82 DTC 1325

The Chairman:—The appeal of “The Laurentian Club Incorporated” is from reassessments by which the Minister of National Revenue disallowed as deductions amounts of $3,074.63, $4,719.83, $4,600 and $3,763 in the taxation years 1975, 1976, 1977 and 1978 respectively, claimed by the appellant as the cost of interest on borrowed money used to maintain its investments and maximize its income therefrom.

The facts:

The appellant at all material times was an organized club and operated exclusively for social welfare, civic improvement, pleasure and recreational purposes and was a non-profit organization within the meaning of paragraph 149(1 )(l) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

Issue:

The facts and the amounts are not in dispute. The use made of borrowed funds by the appellant and the deductibility of the related interest charges are the issues.

In its Notice of Appeal the appellant states:

The facts of the case are as follows:

1. The Club has some reserve of funds which it has placed into investments and deposits in order to earn income.

2. Because of the seasonal form of other income of the Club varying amounts of money would be available for investment purposes and therefore the Club would have to be constantly liquidating investments as required for operations and reinvesting at a later date. It was decided that earning income on a spasmodic basis like this would reduce the possibility of earning the maximum interest in a year.

3. The Club therefore decided that to earn the maximum income it would maintain the investments at a fairly constant level and borrow funds for the variable periods rather than liquidate investments.

4. Therefore it was considered that the interest paid on the borrowing of funds was for the purpose of maintaining the investments and maximizing of the income from them and therefore is properly deductible.

In the Reply to Notice of Appeal, counsel for the respondent submits:

4. He submits that the interest costs of $3,074.63, $4,719.83, $4,600.00 and $3,763.00 incurred by the Appellant in each of its 1975, 1976, 1977 and 1978 taxation years were costs incurred to borrow money used in the operations of the Appellant which were exempt for tax within the meaning of section 149(1 )(I) of the Income Tax Act and therefore were not deductible within the meaning of subsection 18(1)(c) of the Income Tax Act.

Counsel for the respondent filed as Exhibit R-1 a letter from an officer of the Laurentian Club which sets out the use made of the borrowed funds and reads as follows:

April 15, 1977

Revenue Canada Taxation,

360 Lisgar St,

Ottawa, Ontario

K1A 0L9

Attention: Mrs N Deveau

Dear Sir:

Re: 1976 T3 Return and 1975 amended T3 Return.

In the above returns the Club has deducted the interest paid to the bank as a deduction from its investment income. The Club is a non-profit organization and is required to report on its investment income.

The Club collects its fees at one time during the year which means that its cash flow is irregular during year. The Club has followed this plan.

1. At the time the fees are received it has a surplus of funds.

2. The surplus of funds is invested.

3. As club requirements occur money is borrowed from the bank rather than cashing in the investments.

4. When the fees are received in the next year the bank loan is paid off or down and the cycle starts again.

5. In this way the investing of temporary surplus funds can be controlled.

It is our contention that the net of income received less the bank loan interest is the income from investments and we have filed on that basis.

The figures and purpose can be confirmed by the bank if necessary.

Yours very truly,

LAURENTIAN CLUB INC

per

The respondent also filed as Exhibit R-2 a letter from the Bank of Nova scotia dated May 20, 1977, which reads:

May 20, 1977

Laurentian Club Inc,

252 Metcalfe Street,

Ottawa, Ontario

Dear Sirs:

We confirm that the following interest was paid to the Bank in connection with your loans here:

1975	$3,074.63
1976	4,719.83

It is our understanding the funds borrowed from Scotiabank in both years, were for operating purposes.

Yours very truly,

(signed)

D S Dunster,

Manager.

Although Mr E D Berry, who represented the appellant, contended that the Bank of Nova Scotia letter did not accurately reflect the use made of the borrowed funds, the letter is not inconsistent with the Notice of Appeal and indeed with the facts as stated by Mr Berry at the hearing.

It is perhaps useful to note that the Board is sezied with and can only adjudicate the appellant’s appeal with respect to the 1975, 1976, 1977 and 1978 taxation years. It has no jurisdiction with respect to the appellant’s other taxation years.

The appellant has two principal sources of income: membership fees, and interest on its investments. By virtue of paragraph 149(1 )(l) of the Act, income derived from the appellant’s operations is exempt from tax. However, subsection 149(5) of the Act stipulates that non-profit organizations are taxable on interest income realized on its investments.

The appellant, because of the fluctuation in its income from membership fees, decided in the years under appeal not to disturb the source of its interest income and borrowed from the bank funds necessary to meet its operational requirements.

There can be no doubt whatever that the borrowed funds bore a direct relationship to their use in permitting the appellant to continue its operations. Had the appellant not been a non-profit organization, its interest charges on borrowed money may well have been deductible from the taxpayer’s income. That of course is not the case here.

It is Mr Berry’s contention that the interest charges were incurred to earn income for the Club in effect by continually increasing the interest income from its investment and their deduction on that ground should be allowed. I suggest that the appellant’s transactions may have produced that indirect result but the moneys borrowed from the bank were directly related to and used for the appellant’s operations. The income from the appellant’s opera tions being tax exempt, such deductions are clearly prohibited by paragraphs 18(1 )(c) and 20(1 )(c) of the Income Tax Act. The appellant’s appeal is unfortunately wrong in law.

For these reasons, the appeal is therefore dismissed.

Appeal dismissed.