Date: 19980622
Docket: 97-2412-IT-I
BETWEEN:
TOM POPOVICH,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Hamlyn, J.T.C.C.
[1] These appeals are for the Appellant’s 1992, 1993 and 1994 taxation years.
[2] In computing his income for the 1992, 1993 and 1994 taxation years, the Appellant deducted carrying charges and interest expenses in the amounts of $10,711.00, $9,862.73 and $9,803.03, respectively.
[3] In reassessing the Appellant for the 1992, 1993 and 1994 taxation years, concurrent Notices of Reassessment thereof mailed June 18, 1996, the Minister of National Revenue (the “Minister”) disallowed the deduction of the carrying charges and interest expenses.
FACTS
[4] The Appellant was one of four shareholders of a corporation known as Port Hope Investments Corporation (the “Corporation”). The sole asset of the Corporation was a property known as the “Granary”. The intention of the shareholders of the Corporation was to renovate and resell the Granary at a profit. There were two outstanding mortgages on the property. The second mortgage came due, and the mortgagee called the debt. At this point two of the four shareholders resigned from the project. The remaining two shareholders, the Appellant and Leo Hukkano remained in the project by obtaining financing secured against the Appellant’s principal residence. They purchased an assignment of the mortgage in their personal capacity. Subsequently, the construction company that performed renovations on the house placed a lien against the property, ultimately forcing a sale through the courts. The Appellant and Mr. Hukkano decided to purchase the property through a business known as Superior Building Management. In order to obtain financing for the purchase, the Appellant agreed to assign the second mortgage that he held on the property over to the credit company providing the mortgage. Mr. Hukkano purchased the property but registered it in the name of a corporation owned only by Mr. Hukkano. The Appellant initiated court proceedings against Mr. Hukkano, but eventually settled the lawsuit for cash and a re-establishment of a mortgage on the property.
[5] The Minister made the following assumptions of fact:
...
(b) on or about October 10, 1986, the Appellant and a partner entered into an agreement of purchase and sale for the purchase of a real property located at 41-43 John Street, Port Hope, Ontario (the “Property”) at a purchase price of $139,000.00;
(c) on December 9, 1986, Port Hope Investments Corporation (the “Corporation”) was incorporated in the Province of Ontario;
(d) on January 22, 1987, title to the Property was registered under the Corporation’s name;
...
(f) on May 27, 1987, the Appellant and his spouse borrowed $125,000.00 from the Canadian Imperial Bank of Commerce by way of a first mortgage secured by their principal residence;
(g) on September 17, 1987, the Corporation borrowed $150,000.00 from a company, bearing interest at 14% per annum, by way of a second mortgage secured by the Property;
(h) on April 7, 1989, the Appellant and his spouse obtained by way of a second mortgage loan on their principal residence from Canadian Imperial Bank of Commerce the sum of $125,000.00 with interest at the rate of 15.25% per annum;
(i) on April 14, 1989, the Appellant and a partner purchased an assignment of the second mortgage on the Property for a consideration of $160,938.49;
(j) on April 16, 1991, the Property was sold to Canada Fine Art & Frame for $325,000.00;
...
(m) in the 1992, 1993 and 1994 taxation years, the Appellant claimed carrying charges and interest expenses, in the amounts of $10,711.00, $9,862.73 and $9,803.03, ...
[6] The Appellant disagreed with the following Minister’s assumptions:
...
(e) at all relevant times the Property was the only asset of the Corporation;
...
(k) after the April 16, 1991 sale of the Property, the Corporation had no asset and ceased operation;
(l) after the April 16, 1991 sale of the Property, neither the Appellant nor the Corporation had any legal or beneficial interest in the Property;
...
(n) the carrying charges and interest expenses claimed by the Appellant in the 1992, 1993 and 1994 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.
THE MINISTER’S POSITION
[7] The Minister’s position is that the carrying charges and interest expenses claimed by the Appellant in the years were not incurred for the purpose of gaining or producing income from business or property.
ANALYSIS
[8] The deduction of interest is not allowable as a general business expense pursuant to section 18 of the Income Tax Act (the “Act”). Professors Hogg and Magee note in Principles of Canadian Income Tax Law (2nd ed., Carswell) at footnote 36 on page 234:
The Supreme Court of Canada seems to have committed itself to the proposition that, if there were no statutory allowance for the deduction of interest, an interest expense would not be deductible because it is an outlay “on account of capital”, which is not deductible according to s.18(1)(b): Canada Safeway v. M.N.R., [1957] S.C.R. 717, 722-723, 727, [1957] C.T.C. 335, 340-341, 344, 57 D.T.C. 1239, 1241-1242, 1244 (S.C.C.); Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32, 45, [1987] 1 C.T.C. 117, 124, 87 D.T.C. 5059, 5064 (S.C.C.). The proposition is clearly incorrect, being inconsistent with the accepted definition of “capital” expenditures ..., with the tax treatment of interest as income in the hands of the recipient, and with generally accepted accounting principles. However, unless and until the Supreme Court reverses itself on the point, it means that s.20(1)(c) must be complied with in order for an interest expense to be deductible.
[9] The deductibility of interest expenses on money borrowed to earn income from business or property is specifically provided for under paragraph 20(1)(c) of the Act. More specifically, a taxpayer may deduct:
(c) an amount paid in the year or payable in respect of the year (depending on the method regularly followed by the taxpayer in computing the taxpayer's 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),
(ii) 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 (other than property the income from which would be exempt or property that is an interest in a life insurance policy),
...
or a reasonable amount in respect thereof, whichever is the lesser.
[10] In determining whether an expense on account of interest is deductible, the courts have consistently held that it is the current use of the income which determines deductibility. So, where funds were borrowed for an eligible income producing use, but were subsequently used for a non-income producing ineligible use, the interest expense on the loan would cease to be deductible at the moment the use of the funds was changed.[1] The current use rule prevents a taxpayer, whose source of income has disappeared, from claiming a deduction in respect of interest expense.
[11] In Emerson v. The Queen, 86 DTC 6184 (F.C.A.), affirming (F.C.T.D.) 85 DTC 5236, (leave to appeal to the Supreme Court of Canada refused June 12, 1986), Heald J.A. for the Court said the following at 6185:
We are all of the view that the learned trial judge [see 85 DTC 5236] correctly applied the provisions of subsection 20(1)(c) of the Income Tax Act to the facts of this case. We share his view that an essential requirement for interest deductions thereunder is the continued existence of the source to which the interest expense relates. We also agree that where, as in this case, the source has been terminated, the interest expense is no longer deductible. If there were any ambiguity in the English words "a business or property" in subsection 20(1) as to whether the indefinite article "a" should be understood to be repeated before "property", that potential problem is removed by the French version of the Act, where the indefinite article is inserted before both nouns: "d'une enterprise ou d'un bien" (emphasis added). This is also true of the French versions of the same phrase when used in subsections 9(1), 9(2), 12(1) and 18(1) of the Act. The word "property" in subsection 20(1) clearly, therefore, cannot have the collective meaning urged by the appellant.
Accordingly the appeal is dismissed. ...
[12] See also Dockman v. M.N.R., 90 DTC 1804 (T.C.C.), Kornelow v. M.N.R., 91 DTC 431 (T.C.C.).
SUMMARY
[13] The income producing property was sold (April 16, 1991). That source of income for the taxation years was no longer in the hands of the Appellant, therefore for his purposes the source of income was non existent. The placing of a second mortgage as a term of settlement of the litigation on the property in the name of the Appellant does not retroactively give a source of income for the period in question.
DECISION
[14] The appeals are dismissed.
Signed at Ottawa, Canada, this 22nd day of June 1998.
“D. Hamlyn”
J.T.C.C.