Date: 19991112
Docket: 98-1617-IT-I; 98-1618-IT-I
BETWEEN:
VINCENT CASCONE, LOUISE CASCONE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Taylor, D.J.T.C.C.
[1] These are appeals heard on common evidence in Toronto, Ontario on October 20, 1999 against assessments under the Income Tax Act (the "Act") for the years 1991 and 1993 in which the Respondent had disallowed claims for interest expense amounts of $24,434.50 and $16,401.53 respectively (divided 50% each by the Appellants in filing their tax returns).
[2] The Notice of Appeal of Vincent Cascone is reproduced as typical of the Appellant's contentions –
"A. Reasons for the appeal.
1. Upon filing his income tax returns for the 1991 and 1993 taxation years, the Appellant claimed deductions from rental income for various expenses related to the rental property. Included in these deductions, was interest expense in the amount of $12,217 and $8,201 for the taxation years 1991 and 1993 respectively. The interest expenses were claimed as a deduction in respect of rental income earned in those years.
2. By Reassessments dated May 24, 1997 the Minister of National Revenue disallowed the claims for deduction of interest expense in the amount of $12,217 and $8,201 for the years 1991 and 1993 respectively.
3. Notices of Objection were filed on March 24, 1997 with respect to the reassessments under the provisions of subsection 165(1) of the Income Tax Act. In response to the Notices of Objection the Minister of National Revenue issued Notices of Confirmation dated March 27, 1998 under the provisions of subsection 165(3) of the Income Tax Act.
B. Statement of relevant facts in support of the appeal.
1. In 1978, the Appellant and his spouse purchased the property located at 32 Stubbswood Square in Agincourt, Ontario, ("Stubbswood property") and occupied the property as their principal residence.
2. In February 1987, the Appellant and his spouse submitted an offer to purchase a new house situated at 30 Tomlinson Circle, in Markham, Ontario, ("Tomlinson property") at $216,900 to close in January 1988.
3. The Appellant and his spouse intended to purchase the Tomlinson property for the purpose of earning rental income.
4. In the fall and winter of 1987, the Appellant and his spouse began to look for a tenant for the Tomlinson property.
5. The Appellant and his spouse placed advertisements in the Toronto Star newspaper and listed the property for rental or lease with Bungaro Real Estate.
6. At that time, the area surrounding the Tomlinson property was new, remote and with few amenities. The Appellant and his spouse were unable to find any tenant interested at the Tomlinson property.
7. In January 1988, the Appellant and his spouse began to look for a tenant for the Stubbswood property.
8. In January, 1988, the Appellant and his spouse took out a mortgage on the Stubbswood property in the amount of $220,000.
9. The Appellant and his spouse used the funds to acquire the Tomlinson property and paid for land transfer tax and closing costs.
10. In February 1988, the Appellant and his spouse moved into the Tomlinson property and occupied it as their principal residence.
11. Commencing March 1, 1988, the Stubbswood property was rented to an arm's length tenant until it was sold in June 1993.
12. During the 1991, and 1993 taxation years, the Appellant and his spouse received their share of rental income from the Stubbswood property and each claimed mortgage interest expense in the amount of $12,217 and $8,201 as deductions in computing their share of rental income.
C. Statutory provisions and reasons.
The Appellant appeals to this Honourable Court from the reassessments of his 1991 and 1993 income tax returns dated March 24, 1997, with respect to the denial of his claims for the deduction of interest expenses he incurred for the purpose of earning rental income.
The Appellant submits that the interest expenses claimed in 1991 and 1993 taxation years were paid pursuant to a legal obligation on an amount payable for property acquired for the purpose of gaining or producing income from the property or for the purpose of gaining or producing income from a business.
The Appellant submits that the interest expenses claimed in 1991 and 1993 were paid on borrowed money used for the purpose of earning income from a business or property.
The Appellant respectfully requests this Honourable Court to allow this appeal and refer the reassessments for the Appellant's 1991 and 1993 taxation years back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Appellant is entitled to the deductions of interest expense in the amount as claimed for the year.
The Appellant relies on, inter alia, the provisions of section 3, paragraph 20(1)(c), paragraph 18(1)(a) and subsection 45(1) of the Income Tax Act."
[3] For the Respondent the position, from the Reply to the Notice of Appeal was:
"A. Statement of Facts
1. With respect to the preamble of the Notice of Appeal, he admits that the Appellant was reassessed for the 1991 and 1993 taxation years, concurrent Notices of Reassessment thereof mailed on March 24, 1997.
2. He admits the facts stated in paragraph 1 under part A of the Notice of Appeal except he denies that the said interest expenses were incurred to earn income from a rental property.
3. He admits the facts stated in paragraphs 2 and 3 under Part A of the Notice of Appeal except he states that the Notices of Reassessments were mailed on March 24, 1997 and that the Notices of Objection were filed on May 29, 1997.
4. He admits the facts stated in paragraphs 1, 2, 4, 5, 8, 9 and 10 under Part B of the Notice of Appeal.
5. He admits the facts stated in the first sentence of paragraph 6 under Part B of the Notice of Appeal.
6. He has no knowledge of and puts into issue the facts alleged in paragraphs 3 and the second sentence of paragraph 6 under Part B of the Notice of Appeal.
7. With respect to the facts stated in paragraphs 7 and 11 under Part B of the Notice of Appeal, he states that the Appellant signed a lease to rent the Stubbswood Property on January 24, 1988 for the period from March 1, 1988 to February 28, 1989. He further states that the Appellant reported rental losses from renting the Stubbswood Property from 1988 to 1993 before it was sold in October 1993.
8. With respect to the facts stated in paragraph 12 under Part B of the Notice of Appeal, he only admits that the Appellant claimed the said amounts of interest as deductions from rental income in the 1991 and 1993 taxation years respectively.
9. In computing income for the 1991 and 1993 taxation years, the Appellant claimed interest expenses in the amounts of $12,217.00 and $8,201.00 respectively as deductions from rental income.
10. The Minister assessed the Appellant for the 1991 and 1993 taxation years, Notices of Assessment thereof mailed on July 21, 1992 and May 12, 1994 respectively.
11. On June 19, 1995, the Appellant filed a Waiver in respect of normal reassessment period for the 1991 taxation year.
12. In reassessing the Appellant for the 1991 and 1993 taxation years, concurrent Notices of Reassessment thereof mailed on March 24, 1997, the Minister disallowed the deduction of the interest expenses in the amounts of $12,217.00 and $8,201.00.
13. In so reassessing the Appellant, the Minister made the following assumptions of fact:
(a) the facts hereinbefore admitted or stated;
(b) the Appellant's spouse has been a real estate agent, broker and manager since 1976;
(c) the Appellant has been a part-time real estate agent since 1991;
(d) in September 1978, the Appellant and his spouse purchased a property located at 32 Stubbswood Square, Agincourt, Ontario (the "Stubbswood Property") for $106,000.00 as a principal residence;
(e) on January 29, 1988, the Appellant purchased a property located at 30 Tomlinson Circle, Markham, Ontario (the "Tomlinson Property") for $216,900.00;
(f) the purchase of the Tomlinson Property was financed by a mortgage in the amount of $220,000.00 (the "Borrowed Funds"), which was registered on the Stubbswood Property on January 29, 1988;
(g) on February 1, 1988, the Appellant moved from the Stubbswood Property to the Tomlinson Property;
(h) in October 1988, the Appellant sold the Tomlinson Property for $320,000.00;
(i) in October 1988, the Appellant and his spouse used the proceeds of the sale of the Tomlinson Property to purchase another property located at 63 John Striver Crescent, Richmond Hill, Ontario (the "Richmond Hill Property") for $369,900.00 as a new principal residence;
(j) since February 1, 1988, the Appellant rented out the Stubbswood Property;
(k) in October 1993, the Appellant sold the Stubbswood Property for $255,000.00;
(l) in the 1991 and 1993 taxation years, the Appellant reported gross rental income, expenses and rental losses from renting the Stubbswood Property as follows:
1991 1993
Gross rent $18,300.00 $ 9,300.00
Property taxes $ 3,448.85 $ 3,153.00
Maintenance 414.10 8,544.68
Interest 24,434.50 16,401.53
Insurance 526.00 526.00
Light, heat, water other 106.80 141.36
Total expenses $28,930.25 $28,998.99
Net loss $10,630.25 $19,698.99
Appellant's share (50%) $ 5,315.12 $ 9,849.50
(m) in computing income for the 1991 and 1993 taxation years, the Appellant claimed his share of the interest expenses in respect of the Borrowed Funds in the amounts of $12,217.00 and $8,201.00 (the "Amounts") respectively, as deductions from his rental income;
(n) the direct-use of the Borrowed Funds was to purchase the Tomlinson Property which was ultimately used as a principal residence by the Appellant in 1988 and subsequently to purchase the Richmond Hill Property as a new residence;
(o) at the time of the purchase of the Tomlinson Property, the Appellant had knowledge of the real estate market in the area and should have foreseen the difficulty of renting the Tomlinson Property which was situated in a new and remote area with few amenities at that time;
(p) the Appellant would not have a reasonable expectation of profit from renting the Tomlinson Property as the Appellant had financed 100% of the purchase price;
(q) at the time of the purchase of the Tomlinson Property, the Appellant had an intention to sell the Tomlinson Property at a profit which would be fully exempt if it was occupied as a principal residence;
(r) in the 1991 and 1993 taxation years, the interest payments exceeded the rent received in respect of the Stubbswood Property;
(s) the Appellant did not have a reasonable expectation of profit from renting the Stubbswood Property during the 1988, 1989, 1990, 1991, 1992 and 1993 taxation years, and therefore, there was no source of income from the Stubbswood Property;
(t) the Stubbswood Property, the Tomlinson Property and the Richmond Hill Property were not acquired by the Appellant for the purpose of gaining or producing income;
(u) the Borrowed Funds were not used for the purpose of earning income from a business or property but were used to acquire a principal residence;
(v) the Amounts were not paid pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property;
(w) the Amounts were personal or living expenses of the Appellant.
B. ISSUES TO BE DECIDED
14. The issue is whether the Amounts claimed by the Appellant in computing his income for the 1991 and 1993 taxation years were paid pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property.
C. STATUTORY PROVISIONS, GROUNDS RELIED ON AND RELIEF SOUGHT
15. He relies on sections 3, 4, 9 and 67, subsection 248(1) and paragraphs 18(1)(a), 18(1)(h) and 20(1)(c) of the Income Tax Act (the "Act") as amended for the 1991 and 1993 taxation years.
16. He submits that the Amounts claimed by the Appellant in computing his income for the 1991 and 1993 taxation years were not paid pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property as the Borrowed Funds were used to acquire a principal residence and accordingly were personal or living expenses of the Appellant, and that the Appellant was properly reassessed in accordance with paragraphs 18(1)(a), 18(1)(h) and 20(1)(c) of the Act.
17. He further submits that as the Appellant did not have a reasonable expectation of profit from renting the Stubbswood Property in the 1991 and 1993 taxation years and that there was no source of income from the Stubbswood Property, the Borrowed Funds were not used for the purpose of gaining or producing income from a business or property as required by paragraph 20(1)(c) of the Act. Accordingly, the amounts claimed as interest expenses in the 1991 and 1993 taxation years are not deductible pursuant to paragraph 20(1)(c) of the Act.
18. In the alternative, he submits that the deduction of the disallowed interest expenses is prohibited by section 67 of the Act, as they are not reasonable in the circumstances."
[4] It is clear from the above information that there were other issues raised by the Respondent and there could be other possible points in dispute, but I leave those aside since the only issue actually directly dealt with and litigated was that of the two items of interest expense.
[5] The evidence and testimony presented on behalf of the Appellants mirrored that outlined above as far as the basic facts were concerned. There were certain explanations provided for the transaction (or transactions) involved – i.e. second house (Tomlinson) in difficult area for rentals in 1987, but too small for the Appellants when they did attempt to live there in 1988, etc. But I do not consider these points of great value in the consideration of the total picture of the events that are disputed. The matter simply comes down to whether in the known circumstances the amounts at issue are deductible under paragraph 20(1)(c) of the Act.
[6] The agent for the Appellants summarized the two opposing positions, in argument, as:
"-- there was money borrowed against the property, which eventually became a rental property and the appellant deducted the interest from the rental income. However, the Justice takes the position that the money was borrowed for the specific purpose of purchasing a principal residence."
[7] The agent referred the Court to certain case law which in his view supported the Appellants notably: Bronfman Trust v. R. [1987] 1 S.C.R. 32; 36 D.L.R. (4th) 197; 87 DTC 5059 (S.C.C.); John M. Tennant v. H.M.Q. 96 DTC 6121 (S.C.C).; Zahid Mohammad v. H.M.Q. 97 DTC 5503 (F.C.A.).
[8] Provided in advance with copies of the case law upon which the Respondent's counsel intended to comment, the agent also referred to: Evertz v. M.N.R. [1997] 1 C.T.C. 2088, 97 DTC 672 (T.C.C.); Michael v. M.N.R. [1991] 2 C.T.C. 2131, 91 DTC 1076 (T.C.C.); Shell Canada Ltd. v. Canada [1999] S.C.J. No. 30.
[9] Counsel for the Respondent in addition to dealing with the cases noted above, and the summary provided by the agent also made reference to the following cases: Holotnak v. R. [1990] 1 C.T.C. 13, 89 DTC 5527 (F.C.A.); Holman v. Minister of National Revenue [1979] C.T.C. 2653, 79 DTC 594 (Tax Review Board).
[10] The case law such as Tonn v. R. [1996] 1 C.T.C. 205, 96 DTC 6001, 191 R. 182, [1996] 2 F.C. 73 and Mastri v. R. [1997] F.C.J. No. 880, 97 DTC 5420, [1997] 3 C.T.C. 234, dealing with the question "reasonable expectation of profit" was also touched on. But as I noted above, this matter was tried and argued on the question of the interest deductibility as I followed it. The Respondent had referred to this alternate point in the Reply to the Notice of Appeal (supra) but it is not the basis upon which these assessments were struck nor the appeals launched as I comprehend the situation. I would note just for the record (without my comments) the view of the agent for the Appellants on this point:
"I find the assessment rather odious, in the sense that the disallowance of the interest expense produces a larger disallowance than it would have had, (sic) they disallowed the expenses or the losses on a reasonable expectation of profit basis. And it would tend to lead me to suspect that maybe that's what they did. "Well, we won't go on the reasonable expectation basis because we'll only get to disallow the losses, but if we disallow the expense and the interest expense on this technical basis we'll get a bigger disallowance"."
[11] At the conclusion of argument, the Court noted that there could be some relevance to the following case law – but made no further comment and nothing was submitted by either party after the trial although there was an opportunity provided by the Court to do so: Singleton v. R.,[1996] 3 C.T.C. 2873 and Singleton v. The Queen, 99 DTC 5362 (F.C.A.).
Comments
[12] In my view the position of the Appellants is simply that while the funds were borrowed on the security of the original residence (Stubbswood) such funds were used to purchase Tomlinson and the purpose for which was to gain rental income from Tomlinson, fitting neatly into the structure of the Act, above. The position of the Respondent is that the mortgage funds obtained using Stubbswood as security were used to acquire a new residence – Tomlinson – and then to rent Stubbswood. For the Appellants, since efforts described as intended to rent Tomlinson were unsuccessful, the Appellants changed plans – moved to Tomlinson as their principal residence and rented Stubbswood. Ipso facto (according to the agent for the Appellants) they had simply mortgaged Stubbswood and rented it, permitting the deduction of the interest at issue.
[13] The conclusion of the Respondent appears to me to be neatly summarized in paragraphs 13(b), (o) and (q) of the Reply to the Notice of Appeal (above) but for emphasis I would repeat them:
"(b) the Appellant's spouse has been a real estate agent, broker and manager since 1976;
(o) at the time of the purchase of the Tomlinson Property, the Appellant had knowledge of the real estate market in the area and should have foreseen the difficulty of renting the Tomlinson Property which was situated in a new and remote area with few amenities at that time;
(q) at the time of the purchase of the Tomlinson Property, the Appellant had an intention to sell the Tomlinson Property at a profit which would be fully exempt if it was occupied as a principal residence."
[14] In simple language, the Respondent is putting forward that the series of transactions represented a scheme or a plan to accomplish the objective sought – a new residence - while at the same time incurring the minimum tax impact for themselves.
Conclusion
[15] In my view the issue comes down to resolution within the parameters of Shell (supra) and the two Singleton cases (supra). The fundamental question to be asked is:
dealing with the particularly relevant words in paragraph 20(1)(c) of the Act – "borrowed money used for the purpose of earning income from a business or property -- " underlining mine – for what purpose was the borrowed money used?"
[16] While I find the proposition of the Respondent interesting and plausible, it is based on an assumption that taxpayers are somehow barred from looking deeply into, examining carefully, acting deliberately, and bringing about results perceived in the clauses of the Income Tax Act, with direct and tangible benefits to themselves. There is no doubt that looked at in its total context one could string together the detailed actions of the Appellants with the results now seen as insidious, perhaps perfidious by the Respondent. In the labyrinth arising out of efforts at tax minimization I can follow that line of reasoning easily, and I do not castigate the Respondent for so viewing it. But in this matter the issue of "sham", while alluded to and in effect argued by the Respondent was not addressed in the evidence and testimony sufficiently to support the assessment on that basis. I would quote from Singleton (F.C.A. supra) at page 5369:
"On the second point, the Minister does not suggest that what was occurring here was a sham or that there was any concealment; nor does he suggest that the words of paragraph 20(1)(c) are ambiguous. The appellant's borrowing met the terms of paragraph 20(1)(c) in a manner that was not artificial. It would be inappropriate for the Court to decide the question of deductibility of interest on the basis of whether, in the Court's view, the appellant was deserving of interest deductibility."
[17] The "series of transactions" position was also raised by the Respondent and it differs from the "sham" argument above. Currently in Singleton (T.C.C. supra) at page 2878 thereof, Judge Bowman rejects the "sham" basis and turns to a consideration of the series of transactions.
"I do not base my decision on the admitted tax objective that the appellant sought to achieve by the manner in which the transaction was structured, nor do I suggest that the "substance" differed from the "form", or that any of the steps were legally invalid. Such questions do not arise, the only question being the purpose for which the funds were used. In that determination, at least in this case, any attempt to apply the concept of substance over form merely muddies the waters. What the appellant purported to do, he did. I am basing my decision on the fact that, even if one accepts the legal validity of the steps that were taken and also treats the obvious tax motivation as irrelevant, one is still left with the inescapable factual determination that the true economic purpose for which the borrowed money was used was the purchase of a house, not the enhancement of the firm's income earning potential by a contribution of capital."
[18] It is not at all difficult to follow in the painstaking analysis of this Court in Singleton (T.C.C. supra) the logic applied to those events by Judge Bowman and the possible application here. It provides a compelling rationale with which to view the underlying use and purpose for a series of apparently interrelated transactions. However, paragraph from Singleton (F.C.A. supra) at page 5369 deals with this aspect of paragraph 20(1)(c) of the Act, and I must take it into account:
"Finally, the legal and commercial reality of this transaction is that the appellant withdrew his own funds from his law firm to purchase a house. On the same day, he borrowed funds to replace the funds required for his capital account at the firm. In Bronfman Trust, the Court adopted an approach which required the taxpayer to trace the borrowed funds to an identifiable direct use which triggered deductibility of interest under paragraph 20(1)(c). As I have found earlier in these reasons, the appellant has met these requirements. It would be incorrect to ignore the substance of a legally effective borrowing transaction for an income earning purpose in the present appeal."
[19] Judge Bowman made his decision based on the commercial reality of the series of transactions as he saw it. The Federal Court of Appeal based that judgment on an examination of each transaction and eschewed the whole picture view. In Singleton (F.C.A. supra) the borrowed funds were contributed to and used in the law firm to earn income, and the Federal Court of Appeal concluded that "borrowed money was used for the purpose of earning income -- " (underlining mine). The Appellants' position in this case, is that borrowing the funds on the security of "Stubbswood" and renting it is a perfectly supportable transaction under the Act. That view in the eyes of the agent for the Appellants would only be reinforced by the decision in Singleton (F.C.A. supra).
[20] But, in this case can it be said that the $220,000.00 borrowed was ever "used for the purpose of earning income --"? It was used to purchase a property which never earned income (as rent) but only used as a principal residence, and ultimately became a property for sale. I am unable to conclude that Singleton (F.C.A. supra) extends the "single transaction" rule to that degree, as I comprehend it from that case. In Singleton (F.C.A. supra) the borrowed funds at least were contributed – for use in business – directly to the law firm. The Federal Court of Appeal took the view that the purpose for the borrowing – to replace capital funds used to purchase a house – was not relevant for tax matters. In this instant case even if I accept the intention of borrowing (as stressed by the Appellants) was to purchase a rental property, the fact is that the borrowed funds were not used for that purpose. While "intention" and "purpose" might be arguably somewhat interchangeable, they do not equate to "used". As Judge Bowman so aptly and succinctly put it at page 2876 of Singleton (TCC supra):
"It should be observed that words are "used for the purpose of" not "borrowed for the purpose of ... ".
I do not find the basis in Singleton (F.C.A. supra) upon which to accept the Appellants' contention in this matter.
[21] In an effort to review anything which might be of aid to the Appellants, I now turn to the latest chapter in the ongoing saga of paragraph 20(1)(c) of the Act - arising out of Shell (supra). Without examining it in detail it does have at least one point that might be compared to the facts of this present case. In Shell (supra) there was a transaction which intervened between the actual borrowing and the use – that of converting the New Zealand funds into U.S. funds albeit at a much lower interest rate. As I see it the late Chief Judge of this Court (at that time Associate Chief Judge) and the Supreme Court Justices agreed, this did not change the quality of the New Zealand borrowed funds for deductibility under paragraph 20(1)(c) of the Act – the funds "can be directly traced to an income producing use". I do not find that situation to be consistent in this appeal. In Shell (supra) the borrowed funds (transformed or modified though they might have been) still found their eventual destination and use in the business of that appellant according to the Courts. In this case the simple fact is that the rental income (only from Stubbswood) could still have been earned without the borrowed money at all – leaving aside what arrangements the Appellants might have been required to make for their own residence. The purchase of Tomlinson – clearly used only for personal residence and sale – seems quite separate and distinct – not merely a detour (see Shell supra), on the route to earning income – from the transactions involved with Stubbswood – mortgaging, vacating and renting it. The purchase of Tomlinson under the circumstances of this appeal was eventually no different than any other personal disposition of the borrowed funds – it exhibited no characteristics of a business venture. Great emphasis was placed by the agent on the efforts of the Appellants to rent Tomlinson, however unsuccessful. It was pointed out by the Respondent that this was before they owned that property. I am not sure that either of these points is of great significance in the course of these events, the critical fact is that the funds do not even fit into the category of "directly traced to an income producing use" (Shell supra), as I read that case.
[22] While the recent F.C.A. judgment in Singleton (supra) and the even more recent S.C.C. judgment in Shell (supra) might appear on the surface to provide additional solace and relief to some taxpayers and their advisors in an attempt to expand the Jurisprudence and parameters of paragraph 20(1)(c) of the Act, a close examination of those two signal cases should mandate a very cautious approach in any such venture, and a careful review of all the leading cases dealing with this paragraph of the Act.
[23] The appeals are dismissed.
Signed at Ottawa, Canada, this 12th day of November 1999.
"D.E. Taylor"
D.J.T.C.C.