1999-1766(IT)I
BETWEEN:
DARLENE A. BALDNER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on June 19, 2000 at Winnipeg, Manitoba by
the Honourable Judge T. O'Connor
Appearances
Agent for the Appellant: David Baldner
Counsel for the Respondent: Tracy Harwood-Jones
JUDGMENT
The appeals from the reassessments made under the Income Tax Act for the 1993, 1994 and 1995 taxation years are dismissed in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 5th day of September, 2000.
|
"T. O'Connor" |
J.T.C.C.
Date: 20000905
Docket: 1999-1766(IT)I
BETWEEN:
DARLENE A. BALDNER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
O'Connor, J.T.C.C.
[1] This appeal was heard at Winnipeg, Manitoba on June 19, 2000. The Appellant was represented by her agent and husband David Baldner ("spouse") who also testified for the Appellant.
FACTS:
[2] On February 16, 1987 the Appellant purchased 63,000 common shares ("Shares") of Greenstreet Holdings Ltd. ("Greenstreet") from her spouse for $125,000.
[3] Greenstreet owned 100% of Baldner Holdings Ltd., which in turn owned 100% of R. W. Packaging Ltd.
[4] The Appellant financed the Shares purchase by means of a loan from the Canadian Imperial Bank of Commerce ("CIBC") in the amount of $125,000 (the "Share Loan"). The Share Loan was secured by a second mortgage on the home of the Appellant and her spouse.
[5] Originally the home had a first mortgage loan of $250,000 with the CIBC.
[6] The spouse used the $125,000 received by him for the Shares and applied these to reduce the mortgage loan to approximately $125,000. Actually a new mortgage ("Mortgage Loan #1") was executed in 1990 for approximately $125,000 and presumably the original mortgage was discharged.
[7] In 1992 the CIBC called certain personal and business loans as well as the Share Loan. The spouse on January 1, 1993 caused R. W. Packaging Ltd. to sell its assets. The cash proceeds from the sale ($185,000) were used to pay off the loans the CIBC had called, including the Share Loan. The Share Loan was paid partly in 1993 and completely in 1994.
[8] The Appellant and the spouse did not pay off Mortgage Loan #1 as CIBC was not demanding payment of that mortgage.
[9] The Appellant and her spouse were displeased with the CIBC and consequently they arranged for CIBC to assign the balance Mortgage Loan #1 to the Toronto-Dominion Bank ("TD Bank"). The Appellant thus become indebted to the TD Bank in an amount of approximately $125,000 ("Mortgage Loan #2").
[10] In the years in question the Appellant sought to deduct the interest charges on Mortgage Loan #1 and on Mortgage Loan #2.
[11] Although the assets of Greenstreet have changed to cash and to a lesser extent, some investments, the Shares the Appellant acquired continue to be owned by her.
[12] The interest expense on the Share Loan was $7,534 for 1993 and its deduction was allowed.
[13] Interest expense on Mortgage Loan #1 was $5,760 in 1993. The interest expense on Mortgage Loan #1 was $8,106 in 1994. In 1995 the total interest expense on Mortgage Loan #1 and Mortgage Loan #2 was $8,398. The year 1994 was not reassessed for the Appellant and no Notice of Objection by the Appellant was filed with respect to the 1994 year. The $8,106 interest expense for 1994 had been erroneously claimed on the spouse's return and was disallowed.
[14] By Reassessment dated November 19, 1996 the Minister of National Revenue ("Minister") denied the Appellant's claim for deduction of interest by the amount of $7,534 in 1993 and $8,398 in 1995.
[15] The Appellant filed Notices of Objection to these reassessments.
[16] Subsequently the Minister reassessed the 1993 taxation year on February 9, 1999 to allow the deduction in 1993 of $7,534. Further, the Minister confirmed the 1995 reassessment by Notice of Confirmation dated February 9, 1999.
SUBMISSIONS:
[17] The submissions of the Respondent and of the Appellant read in part as follows:
MS. HARWOOD-JONES "(Counsel for the Respondent):
Despite some lengthy and sometimes confusing evidence, I think that the facts in this case are not all that complex.
What we have is a situation where Mrs. Baldner had two loans that we are talking about, and one was in respect of shares that she purchased in Greenstreet, and ...she was legitimately entitled ... to an interest deduction, and that was given by the Minister.
The other loan was a mortgage loan or a personal loan for the purchase of her personal residence. That is not an issue. I think everybody agrees on those facts.
Ultimately the loan with respect to the shares was called by the CIBC. In other words, the CIBC demanded that she pay back that loan. And Mr. Baldner ... sold the assets of the business and received I think it was $185,000.00 or something along those lines as proceeds of that sale, and used a part of the proceeds to pay off the share loan that had been called by the CIBC for Mrs. Baldner.
The mortgage loan, the loan that was taken out to purchase the house still continued to exist. That loan wasn't paid out ...
The share loan, was also secured by the house, but that one was paid out. The mortgage loan still continued to exist and didn't change in nature or in character in any sense.
But because the business loan was called and Mrs. Baldner had been obtaining the interest deduction with respect of the business loan, but because that loan wasn't there anymore, because it had been paid out by Mr. Baldner, now Mrs. Baldner wants to claim an interest deduction for the mortgage.
The Minister's position is, of course, that that mortgage loan has never been used for the purpose of earning income. It was used to acquire the personal residence. And that, of course, is the issue in this case.
In the absence of section 20(1)(c) of the Act, ... there is no deduction allowed in respect of interest without that section, but 20(1) entitles the taxpayer to a deduction in respect of interest, or, pardon me, in respect of an amount that is wholly attributable to, and then we skip down to ... paragraph (c),
"...an amount paid in the year or payable in respect of the year pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from business or property".
That section has been the subject of commentary in the Supreme Court of Canada . ...
[Bronfman Trust v. Canada [1987] 1 S.C.R. 32] is a situation where the trust borrowed funds in order to make a capital allocation to the beneficiary of the trust. The borrowing of the funds was - the allocation was not for the purpose of producing income. It was for the purpose of giving the beneficiary some money.
The trust claimed an interest deduction on the basis that borrowing those funds allowed the trust to retain income producing assets in the trust portfolio. ...
The Supreme Court disallowed the deduction because the borrowed funds were not used for the purpose of producing income, but were rather to make the payment to the beneficiary.
And there are a number of comments by Chief Justice Dixon, as he was at that time, which are germane to the case, and I have highlighted them and noted them.
Paragraph 20, and I have provided the quick law version to Your Honour and to Mr. Baldner, and that is at page 8 of the decision, makes a number of comments that are, in the Minister's submission, important in this case.
"It is important to recall that the purpose of an interest deduction is to encourage the accumulation of capital which would then produce taxable income."
The Supreme Court also reminds us that,
"Not all borrowing expenses are deductible",
and the interest on borrowing as used for non-income earning purposes, for example personal consumption, that is not deductible interest.
The court states that,
"The statutory deduction requires a characterization of the use of the borrowed money as between the eligible use of earning nonexempt income from the business or property and a variety of possible ineligible uses."
And as the court states,
"The onus is on the taxpayer to trace the borrowed funds to an identifiable use which triggers the deduction."
In other words, the taxpayer has to demonstrate that the funds, and it can be through a tracing mechanism, but that these funds are used for an eligible use, in other words, an income producing use.
...
Paragraph 28 of the decision, which is on page 9 of the copy I have provided, is also, in the Minister's submission, very important in this case. As you will see highlighted there, the court says,
"Neither the Income Tax Act nor the weight of judicial authority permits the court to ignore the direct use to which the taxpayer puts borrowed money."
That is very important in this case because the direct use to which the money, the mortgage loan, was put was to purchase the personal residence of the taxpayer. ...
To continue going through this case though, at paragraph 31, which is on page 10, the court indicates that,
"It has been held repeatedly that an individual cannot deduct interest paid on the mortgage of a personal residence even though he or she claims that the borrowing avoided the need to sell income producing assets",
which is not that far away from what we have here.
In this case, the issue is, of course, that the proceeds of the sale of the assets were used to pay out the share loan, as opposed to the mortgage loan.
Finally at paragraph 40 at page 12 of this decision, the court indicates that,
"The taxpayer must satisfy the court that his or her bona fide purpose in using the funds was to earn income."
The Bronfman case was reaffirmed, so to speak, by the Supreme Court in Tennant v. Canada (Minister of National Revenue - M.N.R.) [1996] 1 S.C.R. 305, which I have provided as well.
The facts in that case are essentially that a taxpayer used a loan of a million dollars to purchase shares and then effected a section 85 rollover and obtained shares in a different company, which only had a value of $1,000.00. And the Minister allowed the deduction only to the extent of the value of the replacement shares.
That appeal was allowed as the replacement shares were sufficiently linked to the initial loan ...
The Supreme Court tells us that we need to, in order to have an interest deduction, we need to establish a link between the current eligible use of the property, proceeds of disposition of an original eligible use property if that is the path that is being followed, and the money that was borrowed to acquire the original eligible use property.
In that case, the taxpayer could trace those initial funds, which were used for the purpose of producing income. There was a path that we could follow.
The problem fundamentally in the present case ... is that those funds on the mortgage loan were never, and this was admitted by Mr. Baldner in his testimony, were never borrowed for the purpose of earning income. They were borrowed for the purpose of purchasing a principal residence, which is not an income producing activity.
It is not, this isn't a situation where the funds were then used to repay the business loan or anything like that. In fact, that mortgage, the character of the mortgage never changed and that, I think, is the problem that Mrs. Baldner faces today.
When the business loan was called, Mr. Baldner paid it off, but the mortgage funds were still used for the residence. They weren't converted to any other use.
And effectively, what we have here is a situation where the taxpayer is saying that since she can't have the interest deduction for the business loan, because it was paid off, she would like the interest deduction on a different loan, but the problem that she faces is that that loan has never been used for the purpose of producing income and that is a fundamental requirement, ...
Now Mrs. Baldner wants the interest deduction because if the business loan had not been called then, assuming that Mr. Baldner sold the assets of the company, and we heard testimony that he sold the assets of the company because the loans had been called, but I take the suggestion to be that if the business loans had not been called and the sale had proceeded, then those funds would have been used to pay down the mortgage loan, but he simply didn't have that opportunity.
But again ... we need to look at what was done. In fact, the business loan was paid off. The mortgage remained intact and was never used for business purposes.
And there is no link between the mortgage proceeds or the mortgage loan and an income producing activity. It is not a deductible form of interest. It is a personal loan that was used, and continued to be used at all times, simply for the purpose of obtaining the residence.
Mr. Baldner testified that he paid off the share loan to protect the interest in the house, because the share loan was also secured by a mortgage on the house, a second mortgage, but just because the share loan was a second mortgage doesn't mean that the first mortgage was for business purposes. It still remained a separate type of loan for separate purpose.
I'm speculating at this point, but it may have been that if there was a differently structured transaction, whereby the proceeds from the sale of the business were used to pay off the mortgage loan and then another loan was taken out to pay off the share loan or something like that, then we might be in a situation where there might be a link to be established, but there is simply no link. They are two very separate loan situations here.
Those are my comments on the substantive question of whether the interest deduction is allowed, but I do have a couple of comments on the issue of whether the 1994 appeal is valid.
Now as I understand from the documents that I have filed and from Mr. Baldner's testimony, the 1994 taxation year was initially assessed and allowed as reported on May 26, 1995, and that is evident from the notice of assessment, which is R-4.
The notice of objection for 1994, the official notice of objection, was filed on March 20, 1997, and that is in the bundle of notices of objection, which is R-3.
Mr. Baldner testified that on January 30th of 1997, he wrote a letter to Revenue Canada discussing this notion of transferring the deduction from him to his wife, and the letter from Scarrow and Donald, which is A-9, indicates that. It says,
"Our client had written to Revenue Canada in January 1997 and understood that you would accept that letter as his notice of objection."
That is a letter dated February 28, 1997.
So what we have is a notice of assessment in 1995, in May of 1995, no reassessment, but a request in early 1997, and then a notice of objection subsequent to that request.
It was after that that the Minister made an indication that it was not going to allow that to happen, ...
...
Now section 165 of the Income Tax Act requires a notice of objection to be filed within 90 days after the mailing of the notice of assessment. Of course, a taxpayer can get an extension of time. ...
The application for an extension of time can be made under subsection 166.1(7), that is 1(7), but that section precludes, pardon me, that is the section that precludes the granting of an application unless it is made within one year of the expiration of time otherwise allowing for the filing of the objection, and that is where, of course, we get our one year and 90 days.
In this case, that is on or about August 26, 1996. So it is before there was any indication to Revenue Canada that Mr. Baldner was seeking this transfer of the deduction from himself to Mrs. Baldner, which ultimately was disallowed, would be disallowed in any event, for the same reasons that 1993 and 1995 were disallowed, because the Minister's position is that that is a mortgage loan with no business purpose and, therefore, doesn't meet the requirements of 20(1)(c).
The Minister, of course, would be precluded from granting an extension of time by 166.1(7) and, from my understanding and from the evidence that we have seen, there has not been an application for an extension of time to the Minister.
In any event, the Minister wouldn't be able to allow it and this Court, of course, is bound by the same time constraints, although by a different section.
But in any event, we are past the one year and 90 days for the 1994 and so there simply can be no appeal, because, of course, in order to have an appeal, there must be a valid notice of objection filed.
...
HIS HONOUR: Well, just one question. What do you think of the substance over form advice apparently given by Revenue Canada?
MS. HARWOOD-JONES: Well, of course, that is a legal issue, as to whether a loan is going to meet the requirements of 20(1)(c) and Revenue Canada, of course, can't be held to any legal opinion that it has provided.
Now the evidence on it is relatively sketchy. We have the notes which indicate, in fact, that Revenue, or rather that the accountant appeared to recognize that, normally speaking, this mortgage loan wouldn't fit into the requirements of 20(1)(c).
If indeed Revenue Canada said go ahead and do it, then that is regrettable, but cannot form estoppel. Of course, there cannot be estoppel against the Crown. ...
MR. BALDNER: I would just like to make some comments with respect to the closing.
If I could start by saying that, you know, you said you might hear from Mr. Baldner something different, and when you say, you know, "It seems like they want to get a deduction anyway when the mortgage wasn't for business purposes", I think the -- originally we don't argue that the original mortgage had anything to do with the share loan. It didn't.
We put a mortgage that -- we had a mortgage on our home to finance our home. We had a mortgage, a second mortgage to finance the purchase of the shares of Green Street Holdings, and that we are not arguing with because those are the facts.
However, if I could have changed the events in any way, I would have. If I would have been allowed to pay the mortgage and leave the share loan existing, I would have. I didn't have those choices. ...
The mortgage, the comment was made the mortgage was never used for investment income. Not originally, but it was, because after, after the loan was called by the CIBC, the share loan, our position is that, at that point, since we had the money to pay out the mortgage but weren't allowed to, that we are asking the Court to allow us to deduct the mortgage interest on mortgage one and two, which were the CIBC and TD mortgages on the house.
We're asking that because although the mortgage loan wasn't originally taken out for that purpose, we still had the shares. We still had the investment security. We just didn't have the loan from the bank because they required us to pay it back, but we still had the mortgage.
And so although we don't disagree that it wasn't originally taken out, certainly when the CIBC called the share loan, that is when we checked with Revenue Canada and Revenue Canada advised us that we should, or at last that it was reasonable to take a position of substance over form, ...
As far as tracing the funds and their eligibility back and the fact there should be a direct connection, I would suggest that there is a direct connection and that the direct connection is that, in the beginning, we had a share loan which was called by the CIBC. So we transferred the deduction to a loan which had identical security, both secured by our home, and pretty much identical amounts.
And again that is a substance over form, because it's not as though my wife sold her shares. She didn't sell her shares. She still had the original investment, the original assets or shares that were purchased with the proceeds from the original share loan.
That there should be a bona fide purpose to earn income, well, certainly after the share loan was called, in our mind it was a bona fide purpose for the mortgage, because again it goes back to the fact that we had no choice. We had to pay out the share loan. We would have paid out the mortgage because it was nondeductible. ...
I believe these carrying charges should be allowed for the following reasons.
The taxpayer had no control over the CIBC calling her share loan. The CIBC forced the repayment of her share loan in conjunction with a line of credit to RW Packaging Ltd.
The share loan could not be refinanced because RW was the primary asset held by Baldner Holdings, which was 100 percent owned by Green Street Holdings Inc.
The share loan was 7 percent of the outstanding shares of Green Street Inc., and Darlene still owns those shares today.
Out of a concern for being forced to pay off a deductible share loan, David Baldner asked Doug Smith, of Scarrow and Donald Group, to check with Revenue Canada to see if they would allow the taxpayer to substitute the interest for mortgage one for the share loan.
As Doug attested to today, the share loan and mortgage loan were approximately the same amounts and he explained that to Revenue Canada, and that both loans were secured by a mortgage charged on the home of the taxpayer and her spouse.
Revenue indicated to Doug Smith that it was reasonable with a substance over legal form argument. Based on that discussion, based, pardon me, based on that discussion, the deductions were taken until Revenue ruled to disallow the carrying charges.
And it is our position that the use of the mortgage number one, and later number two, the Toronto Dominion Bank, are reasonable, and I qualify, under the circumstances, because I understand where Revenue is coming from, but I think that under the circumstances, my wife and I feel that it is reasonable to allow the mortgage loan to stand in the place of the share loan, given the circumstances that the taxpayer was faced with.
And I think that that is the essence of what substance over legal form is about. ...
Anyway, I think just in concluding, I think from our standpoint, really it is a matter of substance over legal form. We don't dispute the fact the mortgage -- in fact, we agree that the mortgage originally wasn't taken out for the purchase of shares, but under the circumstances with what took place, we think it is reasonable that if we were forced by the CIBC to pay off the share loan, but not forced to pay off the mortgage loan, and they are the same amounts and secured by the same things, and my wife still carries the shares today, that it should be allowed that we deduct the mortgage loan.
I would also point out to the court that the mortgage loan has been paid off, subsequent to that. So had this not occurred, had the CIBC not come along and called our loan, we would still have that loan today. We would have been deducting the interest and we would probably have it for numerous years to come.
And we aren't -- you know, Revenue Canada then would have -- it would have cost Revenue Canada money, or at least they wouldn't have -- I mean we are arguing about what is, you know, 1993, 1994, 1995, but the fact of the matter is it would have gone on a long time.
We don't have a mortgage anymore. It's all paid off. We're not claiming the mortgage.
So actually Revenue Canada is winning because the CIBC came along and called that loan, because everything is paid off right now.
So we are just asking that it be recognized under the circumstances that because we had no control over CIBC and because they called that loan, the share loan, that you recognize the validity of the mortgage, which originally wasn't taken out for that purpose, but would have been paid away, paid off, and, you know, let us go on for the period in question."
ANALYSIS AND DECISION:
[18] In my opinion the position of the Minister is correct. The interest on the Mortgage Loans is not deductible, as the monies were not borrowed for the purposes of producing income from a business or property as required by paragraph 20(1)(c) of the Income Tax Act. The fact that the Appellant and the spouse would prefer to have paid off the Mortgage Loans with no deductible interest as opposed to paying off the Share Loan resulted from the call of the Share Loan and personal and business loans by CIBC. This in effect is not sufficient to allow for tracing and to consider the interest on the Mortgage Loans as really interest on the Share Loan. The fact the amounts of the Mortgage Loan and the Share Loan were each approximately $125,000 and the fact that the Share Loan was secured on the home just as the Mortgage Loans, again, is not sufficient to qualify for deduction of interest on the Mortgage Loans. With respect to the submission of the Appellant and the "substance over form" argument there can be no estoppel against the Crown with respect to legal advice given by persons in Revenue Canada. This principle is well-established.
[19] Considering that the interest on the Mortgage Loans has not been allowed I need not attempt to clear up the 1994 year as to who was entitled to deduct that interest nor need I deal with the fact that since no Notice of Objection was filed by the Appellant for 1994, or whether any of the correspondence could be considered as a Notice of Objection but, in any event, I believe once again that submissions of Counsel for the Respondent are correct. Since no Notice of Objection was filed for 1994 there can be no valid appeal before this Court for that year.
[20] Consequently the appeals are dismissed.
Signed at Ottawa, Canada, this 5th day of September, 2000.
|
"T. O'Connor" |
J.T.C.C.
COURT FILE NO.: 1999-1766(IT)I
STYLE OF CAUSE: Darlene A. Baldner v. The Queen
PLACE OF HEARING: Winnipeg, Manitoba
DATE OF HEARING: June 19, 2000
REASONS FOR JUDGMENT BY: The Honourable T. O'Connor
DATE OF JUDGMENT: September 5, 2000
APPEARANCES:
Agent for the Appellant: David Baldner
Counsel for the Respondent: Tracy Harwood-Jones
COUNSEL OF RECORD:
For the Appellant:
Name:
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada