T-335-79
Phyllis Barbara Bronfman Trust (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Marceau J.—Montreal, October
25; Ottawa, November 28, 1979.
Income tax — Income calculation — Deductions — Trusts
— Plaintiff receiving 50 per cent of revenue from trust prop
erty plus capital allocations at discretion of trustees — Two
capital allocations were made by trustees but the money was
borrowed for that purpose instead of the securities being sold
— Whether plaintiff is allowed to deduct interest payments
from income as money "used for purpose of earning income
from a business or property" — Income Tax Act, R.S.C. 1952,
c. 148, ss. 11(1)(c), 12(1)(a) — Income Tax Act, S.C. 1970-71-
72, c. 63, ss. 18(1)(a), 20(1)(c).
Trans-Prairie Pipelines Ltd. v. Minister of National
Revenue 70 DTC 6351, distinguished.
INCOME tax appeal.
COUNSEL:
M. Vineberg for plaintiff.
R. Roy for defendant.
SOLICITORS:
Phillips & Vineberg, Montreal, for plaintiff.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
MARCEAU J.: The plaintiff is a trust established
in 1942 by one Samuel Bronfman in favour of his
daughter. Pursuant to the deed of trust, the latter,
as the institute, is entitled to receive annually 50
per cent of the revenues from the trust property
and may from time to time be assigned, at the
discretion of the trustees, capital allocations of
that property. In December 1969 and March 1970,
two capital allocations in the amounts of $500,000
and $2,000,000 respectively were so made by the
trustees to the institute. At the time, the assets of
the trust, all of an income-earning nature, consist
ed of a portfolio of securities in public and private
companies having a cost base in excess of
$15,000,000 and a fair market value estimated at
more than $70,000,000. It was felt by the trustees
and their financial advisers, however, that the time
was not appropriate for disposing of any of those
securities, so, in order to give effect to the alloca
tions, money was each time borrowed from a
Bank. The question that arises here is whether the
plaintiff was entitled, as it claimed, to deduct from
its earnings, for income tax purposes, the interests
it paid to the Bank ($110,114 in 1970, $9,802 in
1971 and $1,432 in 1972) until the loans were
redeemed in 1972.
The legislative provisions here concerned are
contained in paragraphs 11(1)(c) and 12(1)(a) of
the Income Tax Act, R.S.C. 1952, c. 148, for the
1970 and 1971 taxation years and in paragraphs
18(1)(a) and 20(1)(c) of the new Act, S.C. 1970-
71-72, c. 63 for the 1972 year. Pursuant to these
provisions, interest on borrowed money is deduct
ible if the money was "used for the purpose of
earning income from a business or property".
The plaintiff's contention is that even if the
proceeds of the loans negotiated with the Bank
were actually used to pay the allocations made in
favour of the institute, they must still be deemed to
have been "used for the purpose of earning income
from ... property" within the meaning of the Act,
since their use allowed the trust to retain securities
which were income producing and which moreover
increased in value before the loans were redeemed.
This contention, according to counsel, would be
directly in line with the decision rendered by the
Exchequer Court, in 1970, in the case of Trans-
Prairie Pipelines Ltd. v. M.N.R. 70 DTC 6351.
The defendant disagrees, and in my view rightly
so.
The Trans-Prairie Pipelines decision, as I
understand it, cannot be taken as an authority for
the submission advanced by the plaintiff and such
a submission appears to me to be unacceptable in
view of the language used by the legislator in the
applicable sections of the Acts.
The facts in the Trans-Prairie Pipelines case
and the decision of the then President of the
Court, Sackett P., are summarized in the headnote
as follows:
The appellant company was incorporated in 1954 to con
struct and operate a pipeline, its original issued capital being a
number of common shares and 140,000 redeemable preferred
shares, the latter having a total par value of $700,000. In 1956
the company issued $700,000 first mortgage bonds and used
$400,000 of the amount so borrowed (with $300,000 obtained
by issuing additional common shares) to redeem the preferred
shares. In 1956 (and subsequent years) the company deducted
the interest paid on its bonds; in 1956 it also deducted (under
section 11(1)(cb)) legal expenses incurred in connection with
the bond issue and the preferred share redemption. The Minis
ter allowed the company to deduct only three-sevenths of the
claimed expenses. The Minister took the position that four-sev
enths, or $400,000, of the money borrowed through the issue of
bonds was used by the company to redeem its preferred shares
and not used for the purpose of earning income from its
business; that interest on the $400,000 was therefore not
deductible under section 11(1)(c); and that legal expenses
incurred in the course of borrowing only $300,000 of the
$700,000 could be deducted under section 11(1)(cb). When the
Appeal Board (65 DTC 642) agreed with the Minister's inter
pretation, the company appealed to the Exchequer Court.
Held: The appeal was allowed. The appellant company was
entitled to deduct all of the interest paid on its bonds during the
years in question and all of the legal expenses claimed under
section 11(1)(cb). The whole of the $700,000 borrowed on the
bonds was, during those years, borrowed money used for the
purpose of earning income from the company's business within
the meaning of section 11(1)(c). Prior to the transactions in
question, the capital being used for the purpose of earning
income from the company's business was the $700,000 sub
scribed by the preferred shareholders and the amount sub
scribed by the original common shareholders. After those trans
actions, the money subscribed by the preferred shareholders
had been withdrawn and what the company was using in its
business to earn income was the amount subscribed by common
shareholders (original and additional) and the $700,000 of
borrowed money. As a practical matter of business common
sense, the $700,000 of borrowed money went to fill the hole left
by the redemption of the $700,000 preferred shares. Surely,
what must have been intended by section 11(1)(c) was that the
interest should be deductible for the years in which the bor
rowed money was employed in the business rather than that it
should be deductible for the life of the loan as long as its first
use was for the purpose of earning income from the business.
I see this decision as an application of the
well-known principle laid down in tax cases where
by it is the actual and real effect of the transaction
or the series of transactions in question that must
be looked at rather than its or their legal or
apparent aspect. The transactions entered into by
the company in the Trans-Prairie case had the
sole effect of replacing, as part of its capital, the
money originally subscribed by the preferred
shareholders by money borrowed through the issue
of bonds. A mere change of creditors had thereby
been effected, without any modification in the
financial position of the company. Through a
proper interpretation of the word "use", as it
appeared in subparagraph 11(1)(c)(î) of the Act
then in force, the learned President avoided the
unacceptable result according to which the taxing
authority could benefit from transactions com
pleted for that sole purpose.
The situation in the case at bar is quite differ
ent. The money was not borrowed here to redeem
a debt previously incurred to acquire the income
earning property of the trust. The series of trans
actions entered into by the trustees—i.e. the capi
tal allocations, the borrowing of money, the pay
ment to the institute, and by so doing the retaining
of securities which otherwise would have been
disposed of—did more than simply change the
composition of the income earning property of the
trust: that property was definitely reduced by some
$2,500,000. While the decision in the Trans-Prai
rie case left the taxing authority in the same
position as that in which it was prior to the
agreement, the decision here sought by the plain
tiff would mean that without doing anything that
could enhance the value of its property, or even
anything that could change the composition of its
assets, the trust could nevertheless render non-tax
able part of its income.
Counsel for the plaintiff argued with force that
the end result of the transactions was the same as
if the trustees had sold assets to pay the allocations
and then borrowed money to replace those assets,
in which case the interest on the loans no doubt
would have been deductible. But, I do not agree
that the result would have been the same. If assets
had been sold, these would have remained income
producing and therefore tax producing, and the
borrowed money would have been added to the
total amount of income and tax-producing capital,
whereas here, no money was added to the tax-pro
ducing capital. That is a difference which, to my
mind, is decisive in view of the rationale that lies
behind the rules laid down by Parliament with
respect to the deductibility for income tax pur
poses of interest payable by a taxpayer on bor
rowed money.'
In my view, it cannot be said that in the circum
stances of this case the money borrowed from the
Bank by the plaintiff was "used ... [to earn]
income from ... property" within the meaning of
the former and present Income Tax Acts, and the
Minister was right in disallowing deduction of the
interest payable thereon.
The appeal will therefore be dismissed.
I Compare Sternthal v. The Queen 74 DTC 6646.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.