Garneau (J.V.) v. Canada, [1995] 1 CTC 2978

Bowman J.T.C.C.:—These appeals, from assessments for the 1990, 1991 and 1992 taxation years, were heard together. They involve a very narrow issue having to do with the deduction of interest. The facts are simple and are not disputed.

In 1990 Mr. and Mrs. Garneau sold their home in Branchton, Ontario and bought another home for $250,000 in Burlington. When the sale of their Branchton house was to close it turned out that the purchasers could not raise all of the cash necessary and Mr. and Mrs. Garneau were forced to take a vendor take back second mortgage of $45,000.

They had counted on receiving cash and as a result had arranged for a mortgage of $150,000 to purchase their Burlington residence. When they did not receive the $45,000 cash as part of the proceeds on the sale of their Branchton home that they were counting on, they were obliged to increase the mortgage on their new home to the maximum allowable, $187,500.

In the years 1990, 1991 and 1992 they received $6,600, $2,200 and $2,100 as interest on the VTB mortgage. They did not include in income the amounts received in 1990 and 1991. Rather, they each included one- half of the total amount received in the three years ($10,900) in their respective incomes for 1992, and deducted in that year $6,049.24 as carrying charges, being the interest paid to the bank on the additional $45,000 that they had to borrow.

The Minister reassessed to include the interest received in each year on the VTB mortgage. Mr. Garneau acknowledged that the interest inclusion should be done on an annual basis, as the Minister has done. He argues, however, that he and Mrs. Garneau should be entitled to deduct, in each of the years, the interest paid on the additional $37,500 that they were forced to borrow from the bank as the result of having to accept from the purchasers of their former house a VTB mortgage instead of cash. He argues, with considerable logic, that had they not had to take back a mortgage they would not have had to borrow the additional $37,500 from the bank. Therefore, he says, the additional interest that they paid to the bank was a direct result of having to take back a mortgage from the purchasers.

There is a certain rough-and-ready economic fairness and common sense to what he says, and his reasoning was appealing enough that I decided to reserve judgment so that I could analyze it.

There is an economic relationship between the interest receipt and the interest expense in the sense that the event giving rise to the former was equally the event necessitating the latter. Where there is a parallel payment and receipt of interest it does not necessarily follow that the purpose of the former is to achieve the latter. The true purpose of the use of the borrowed funds must be ascertained. In Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059, the deductibility of interest on money borrowed and used for the purpose of making a capital distribution to a beneficiary of the trust was held not to be deductible, notwithstanding the somewhat implausible argument that the borrowing obviated the necessity of selling trust assets that yielded an interest rate that was but a fraction of that paid on the borrowed funds. In Mark Resources Inc. v. Canada, [1993] 2 C.T.C. 2259, 93 D.T.C. 1004, this Court denied the deductibility of interest on borrowed funds used to implement a plan to absorb into the Canadian parent’s income losses of a foreign subsidiary.

For the interest paid to the bank on the additional $37,500 to be deductible here it would be necessary to conclude that it was paid on "borrowed money used for the purpose of earning income from...property" (1.e., the VTB mortgage) as required by subparagraph 20(l)(c)(i)?

The additional $37,500 that they borrowed from the bank was used to enable the appellants to buy a residence (a so-called non-eligible purpose), not for the purpose of lending to the purchasers. The additional borrowing may have resulted from their not having the cash that they had originally expected but it cannot be said that they borrowed in order to lend money at interest to the purchasers. Notwithstanding the rather appealing common sense to Mr. Garneau’s argument I do not think that the additional interest paid falls within the wording of paragraph 20(1)(c), or within the principles stated in Bronfman.

The reasoning advanced is somewhat reminiscent of that rejected by the Exchequer Court in Gunnar Mining Ltd. v. M.N.R., [1965] C.T.C. 387, 65 D.T.C. 5241, aff’d by the Supreme Court of Canada, [1968] C.T.C. 22, 68 D.T.C. 5035.

The appeals are dismissed.

Appeals dismissed.