A-1082-87
Her Majesty the Queen (Appellant)
v.
Said Mohammad Attaie (Respondent)
INDEXED AS: M.N.R. v. ATTAIE (CA.)
Court of Appeal, Heald, Stone and Desjardins
JJ.A.—Toronto, June 6; Ottawa, June 14, 1990.
Income tax — Income calculation — Deductions — Trial
Judge holding mortgage interest deductible under s. 20(1)(c)(i)
— Taxpayer investing funds in high interest-bearing term
deposits, not paying off mortgage as intended when money
borrowed — Appeal allowed — Borrowed funds not related
directly to income-producing investment so as to make costs of
borrowing related to income produced.
This was an appeal from the judgment of Collier J. holding
that interest paid on a mortgage was deductible under subpara-
graph 20(1)(c)(i). When the respondent purchased a house in
1978, he obtained a fully open mortgage, at a higher interest
rate, as he intended to pay it off as soon as he was able to move
his money out of Iran. The respondent rented out the home at
first, but occupied it with his family as a principal residence as
of June 1980. Although his funds from Iran arrived in May or
June 1979, the respondent decided not to pay off the mortgage,
but to invest the money in term deposits as the interest rate
thereon was substantially higher than that on the mortgage.
The Minister allowed the interest amounts paid on the bor
rowed mortgage funds to be deducted from the rental income,
but disallowed their deduction from the interest received from
the term deposits. The Trial Judge allowed the latter deduction,
reasoning that it was the taxpayer's purpose in using the
borrowed money, not the purpose of the borrowing (i.e., the
current use, not the original use) which was relevant. The
appellant argued that His Lordship erred in finding that the
use of the borrowed money to purchase a home ceased when the
respondent invested other funds in income-earning deposits.
The respondent argued that at all relevant times the borrowed
funds were used for the bona fide purpose of producing income.
The interest rate obtained on the invested funds exceeded at all
times the interest rate on the mortgage. Unlike the situation in
Bronfman Trust v. The Queen, the taxpayer had a reasonable
expectation that the income from investment of the funds from
Iran would exceed the interest payable on the like amount of
debt.
Held, the appeal should be allowed.
The purpose of subparagraph 20(1)(c)(i) was to encourage
the accumulation of capital which would produce taxable
income. According to Bronfman Trust, the statutory provisions
require that the inquiry be centred on the use to which the
taxpayer put the borrowed funds. Their current use rather than
their original use is relevant in assessing deductibility of inter
est payments. Once the house ceased to be a rental property,
interest paid on the mortgage was no longer deductible since
the income-producing property aspect of the house ceased to
exist. The current use became a non-eligible use. The fact that
the respondent decided to maintain the borrowing and use the
funds from Iran to make a more profitable investment did not
render interest paid on borrowing "interest on borrowed money
used for the purpose of earning income from a business or
property." The indirect use of the borrowed funds did not
permit deduction of the interest paid thereon so as to retain
personal funds for use as income-producing investment. The
argument based on the indirect use of borrowed money was
specifically rejected in Bronfman Trust. It was held that the
Act requires tracing the use of borrowed funds to a specific
eligible use. There is no tracing here of the borrowed funds to
the income earned. The borrowed funds were put to a non-eli
gible use while the personal funds were used so as to produce
income. The taxpayer had to satisfy the Court that his bona
fide purpose in using the funds was to earn income. The
borrowed monies were not used by the respondent to earn
income from business or property, but to finance his personal
residence.
STATUTES AND REGULATIONS JUDICIALLY
CONSIDERED
Income Tax Act, S.C. 1970-71-72, c. 63, ss. 20(1)(c)(i),
178(2) (as am. by S.C. 1976-77, c. 4, s. 64(1); 1980-
81-82-83, c. 158, s. 58; 1984, c. 45, s. 75).
CASES JUDICIALLY CONSIDERED
APPLIED:
Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32;
(1987), 36 D.L.R. (4th) 197; [1987] 1 C.T.C. 117; 87
DTC 5059; 25 E.T.R. 13; 71 N.R. 134.
DISTINGUISHED:
Trans-Prairie Pipelines, Ltd. v. M.N.R., [1970] C.T.C.
537; (1970), 70 DTC 6351 (Ex. Ct.); Sinha (BBP) v
MNR, [1981] CTC 2599; (1981), 85 DTC 613 (T.R.B.).
REVERSED:
The Queen v. Attaie (S.M.), [1987] 2 C.T.C. 212; (1987),
87 DTC 5411; 13 F.T.R. 147 (F.C.T.D.).
REFERRED TO:
Emerson (R.I.) v. The Queen, [1986] 1 C.T.C. 422;
(1986), 86 DTC 6184 (F.C.A.); Attaie (SM) v MNR,
[1985] 2 CTC 2331; (1985), 85 DTC 613 (T.C.C.).
COUNSEL:
Ian MacGregor, Q.C. and S. Patricia Lee for
appellant.
C. M. Loopstra, Q.C. for respondent.
SOLICITORS:
Deputy Attorney General of Canada for
appellant.
Loopstra, Nixon & McLeish, Rexdale,
Ontario, for respondent.
The following are the reasons for judgment
rendered in English by
DESJARDINS J.A.: This is an appeal from a
decision of the Trial Division [ [1987] 2 C.T.C.
212] whereby Collier J. concluded that interest
amounts paid on borrowed money used to purchase
a family dwelling were deductible from the tax
payer's income for the taxation years 1980, 1981,
1982 pursuant to subparagraph 20(1)(c)(i) of the
Income Tax Act' ("the Act").
The facts are not in dispute.
The respondent, a native of Iran, is married with
two children. He first came to Canada without his
family in 1978. He then decided to move himself
and his family permanently to Canada. He looked
for a house. In October, 1978, he entered into an
agreement to buy a home in the Don Mills area of
Toronto. The closing date was December 29, 1978.
The purchase price was $105,000. The respondent
at that time had $60,000 in funds. He signed a
mortgage agreement in order to borrow $54,000. It
was a fully open mortgage, repayable at any time,
maturing November 30, 1983. The respondent
insisted on those terms, at the cost of paying
further interest and against the advice of his real
estate agent, in view of the fact that he had
approximately $200,000 in funds in Iran. He
expected to move such monies out of that country
within a matter of months and was anxious to
repay the mortgage loan without notice or bonus.
Income Tax Act, S.C. 1970-71-72, c. 63.
He returned to Canada in 1979. The home in
Don Mills was rented until the end of May, 1980.
For those first five months of 1980, the defendant
reported rental income in his tax return. He
deducted expenses in respect of the property
including the interest paid pursuant to the mort
gage. The interest expense was allowed by the
revenue department.
From June 1, 1980, the respondent and his
family occupied the home as the principal resi
dence. The $200,000 in funds from Iran arrived in
this country in May or June, 1979. At this time
the interest rate on term deposit investments was
substantially higher than the mortgage interest the
respondent was paying on the loan. He decided not
to pay off the mortgage but invested the $200,000
instead. He did so until February, 1983 when, on
account of a decrease in the interest rate on term
deposits, he paid off the mortgage loan.
In his 1980, 1981 and 1982 income tax returns,
the respondent declared the interest received from
the term deposits as income. He sought to deduct
the interest amounts paid on the borrowed mort
gage funds. The amounts claimed were:
1980 $3,260.63
1981 $5,543.33
1982 $2,739.58
The Minister disallowed those deductions.
The Trial Judge allowed the deductions, thus
confirming the Tax Court. 2 He stated that accord
ing to the decision of the Supreme Court of
Canada in Bronfman Trust v. The Queen' it was
not the purpose of the borrowing which was rele
vant: it was the taxpayer's purpose in using the
borrowed money: the current use, not the original
use, was relevant. Then he said:
Here, the defendant's original purpose was to obtain funds to
complete the purchase of the home. Once he received the funds
from Iran that use of the borrowed funds, in a practical
business sense, ceased. He made a carefully thought-out deci
sion to maintain the borrowing in order to invest in attractive
2 Attaie (SM) v MNR, [1985] 2 CTC 2331 (T.C.C.). The
Tax Court's decision was rendered at the time Bronfman Trust
v. M.N.R. had reached the Federal Court of Appeal, but before
the Supreme Court of Canada's decision.
[1987] 1 S.C.R. 32.
term deposits and earn income. This was done with an eye to
the practical commercial and economic realities at the time.'
In his view, the respondent was then in the same
situation as that found in the case of Sinha (BBP)
v MNR 5 referred to by Dickson C.J. in Bronfman
Trust where, with regard to Sinha, Dickson C.J.
said:
Conversely, a taxpayer who uses or intends to use borrowed
money for an ineligible purpose, but later uses the funds to earn
non-exempt income from a business or property, ought not to
be deprived of the deduction for the current, eligible use: Sinha
v. Minister of National Revenue, [1981] C.T.C. 2599 (T.R.B.);
Attaie v. Minister of National Revenue, 85 D.T.C. 613
(T.C.C.) (presently under appeal). For example, if a taxpayer
borrows to buy personal property which he or she subsequently
sells, the interest payments will become prospectively deduct
ible if the proceeds of sale are used to purchase eligible
income-earning property.°
The Trial Judge concluded:
The Sinha decision was not appealed. I note the factual
pattern there was quite similar to the factual pattern here. The
Supreme Court, in that passage, made no adverse remarks
about those two decisions.
This defendant has, in my view, brought himself within the
converse proposition set out by the Chief Justice.'
The appellant's position is that the borrowed
monies were used by the respondent to purchase a
property which served as the respondent's personal
residence during the taxation years 1980, 1981 and
1982. It was an error, both in fact and in law, for
the Trial Judge to find that such use ceased when
the respondent invested other funds in income-
earning deposits. Once the property became
occupied as a personal residence, it could not be
found that the direct and actual use of the bor
rowed monies was for the purpose of earning
monies from a business or property. It should not,
therefore, have been held that the interest on the
mortgage was deductible under the provisions of
subparagraph 20(1)(c)(i) of the Act.
The respondent's position is that at all relevant
times the borrowed funds were used, as found by
the Trial Judge, for the bona fide purpose of
producing income. The respondent taxpayer finds
4 At p. 216.
5 [1981] CTC 2599 (T.R.B.).
6 Bronfman Trust, supra, at p. 47.
7 At p. 217.
himself in the exceptional circumstances described
by Dickson C.J. in Bronfman Trust. Despite the
fact that the borrowed funds were originally used
to purchase a residence which was subsequently
occupied by the taxpayer, the interest rate which
the taxpayer was able to obtain in the invested
funds exceeded, at all times, the interest rate
payable on the mortgage. The borrowed funds
involved the production of income in a situation
where no other arrangement of financing could
produce the same high rate of profit with conse
quent greater net tax liability. Had the taxpayer
retired the mortgage immediately upon the receipt
of the funds from Iran, and then subsequently
obtained a new mortgage to allow for the making
of investments, both the income which he would
have produced and the net tax liability would have
been far less than the respective income generated
and the tax payable as a result of his efforts to
augment his income-earning potential. This, he
submits, meets the intent Parliament had in adopt
ing subparagraph 20(1)(c)(i) of the Act. Unlike
Bronfman Trust, the taxpayer here can point to a
reasonable expectation that the income yield in
investment of the funds received from Iran would
exceed the interest payable on the like amount of
debt. To deny the deductibility of interest in
favour of a non-beneficial requirement of form is
to discourage the accumulation of capital produc
ing taxable income contrary to the legislative
intent. The commercial and economic reality
makes it appropriate to allow the taxpayer to
deduct the interest on the funds notwithstanding
that they were not originally borrowed for the
purpose of gaining or producing income.
I agree with the appellant's position.
The relevant parts of subparagraph 20(1)(c)(i)
read at the relevant time thus:
20. (1) Notwithstanding paragraphs 18(1)(a), (b) and (h),
in computing a taxpayer's income for a taxation year from a
business or property, there may be deducted such of the
following amounts as are wholly applicable to that source or
such part of the following amounts as may reasonably be
regarded as applicable thereto:
• • •
(c) an amount paid in the year or payable in respect of the
year (depending upon the method regularly followed by the
taxpayer in computing his 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),
The purpose Parliament had in mind in adopting
such provisos was assessed by Dickson C.J. in
Bronfman Trust in the following terms:
I agree with Marceau J. as to the purpose of the interest
deduction provision. Parliament created s. 20(1)(c)(i), and
made it operate notwithstanding s. 18(1)(b), in order to encour
age the accumulation of capital which would produce taxable
income. 8
According to Bronfman Trust, the statutory
provisions require that the inquiry to be made, be
centred on the use to which the taxpayer put the
borrowed funds. Their current use rather than
their original use is relevant in assessing deducti-
bility of interest payments.
It is not disputed that the interest payments on
the mortgage were correctly deducted from the
revenue earned for the period of time the respond
ent's house was used as a rental property. Once the
house ceased to be a rental property, interest paid
on the mortgage was no longer deductible since the
income-producing property aspect of the house
ceased to exist. The current use of the monies
became a non-eligible use. The fact that the
respondent decided to maintain the borrowing and
use the funds received from Iran to make a more
profitable investment, does not render the interest
paid on borrowing "interest on borrowed money
used for the purpose of earning income from a
business or property" as these words are found in
subparagraph 20(1)(c)(i) of the Act. In Bronfman
Trust, Dickson C.J. said:
... 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 investments. 9
The same applies although what was contem
plated here was not borrowing so as to prevent a
sale of assets like in Bronfman Trust but borrow
ing for the use of a personal residence so as to
retain personal funds for use as an income-produc-
8 Bronfman Trust, supra, at p. 45.
9 Bronfman Trust, supra, at p. 50.
ing investment. The borrowed funds are not relat
ed directly to the income-producing investment so
as to make the costs of the borrowing related to
the income produced. 10
The indirect use of the borrowed funds do not
make this deduction possible. In Bronfman Trust,
supra, the argument based on the indirect use of
borrowed money was specifically rejected. There
the trustees of a trust fund who had followed
investment policies which were focused more on
capital gains than on income, borrowed money to
make capital allocations to the beneficiary instead
of selling shares in the trust fund since they were
of the view that such sale, at the time, would have
been commercially inadvisable. They attempted to
deduct the interests paid on the loan as against the
income of the trust fund. The Supreme Court of
Canada declined to characterize the transaction on
the basis of a purported indirect use of borrowed
monies to earn income giving rise to a deduction.
According to Dickson C.J.:
... neither the Income Tax Act nor the weight of judicial
authority permits the courts to ignore the direct use to which a
taxpayer puts borrowed money."
On the contrary, he said:
... the text of the Act requires tracing the use of borrowed
funds to a specific eligible use, its obviously restricted purpose
being the encouragement of taxpayers to augment their
income-producing potential. This, in my view, precludes the
allowance of a deduction for interest paid on borrowed funds
which indirectly preserve income-earning property but which
are not directly "used for the purpose of earning income from
... property". ' 2
There is no tracing here of the borrowed funds
to the income earned. The borrowed funds were
put to a non-eligible use while the personal funds
were used so as to produce income.
The respondent claims that contrary to Bronf-
man Trust, his assets were income-producing so he
finds himself in the special circumstances
10 See Emerson (R.I.) v. The Queen, [1986] 1 C.T.C. 422
(F.C.A.).
11 Bronfman Trust, supra, at p. 48.
12 Bronfman Trust, supra, at pp. 53-54. Emphasis added.
described by Dickson C.J. in Bronfman Trust.
What Dickson C.J. said is the following:
Even if there are exceptional circumstances in which, on a
real appreciation of a taxpayer's transactions, it might be
appropriate to allow the taxpayer to deduct interest on funds
borrowed for an ineligible use because of an indirect effect on
the taxpayer's income-earning capacity, I am satisfied that
those circumstances are not presented in the case before us. It
seems to me that, at the very least, the taxpayer must satisfy
the Court that his or her bona fide purpose in using the funds
was to earn income. In contrast to what appears to be the case
in Trans-Prairie, the facts in the present case fall far short of
such a showing."
In Trans-Prairie Pipelines, Ltd. v. M.N.R., 14
the appellant company was in the business of
constructing and operating a pipeline. At one point
in time it needed more capital for expansion. Its
original capital, when it started business in 1954,
was composed of common shares and preferred
shares. It discovered however it was impossible,
practically speaking, to float a bond issue unless it
first redeemed its preferred shares, because of the
sinking fund requirements of its preferred shares.
It therefore had no choice but to redeem its pre
ferred shares. To do so, it paid $700,000 to the
holders of the preferred shares. It then borrowed
$700,000 by way of a bond and raised a further
$300,000 by issuing additional common shares. In
the course of carrying out these transactions, the
preferred shares were redeemed by using the
$300,000 obtained by the new issue of common
shares and by taking $400,000 out of the $700,000
received on the floating of the bond issue. The
question arose as to whether the appellant was
entitled to a deduction of the whole or only part of
the interest payable on such bonds by virtue of
what was then paragraph 11(1) (c) of the Income
Tax Act, R.S.C. 1952, c. 148, a section analogous
to subparagraph 20(1)(c)(i) of the Act. Jackett P.
(as he then was) was of the opinion that the whole
of the $700,000 was borrowed money used for the
purpose of earning income from the appellant's
business and not only the $300,000, as claimed by
the Minister, with the result that all the interests
borrowed on the bonds were deductible. Jackett P.
said that the whole $700,000 "went to fill the hole
3 Bronfman Trust, supra, at p. 54.
14 [1970] C.T.C. 537 (Ex. Ct.).
left by redemption of the $700,000 preferred
shares". 15 Dickson C.J. upheld such reasoning.'
The taxpayer, in the case at bar, is far from
meeting the special circumstances of Trans-Prai
rie Pipelines. What was said by Dickson C.J. in
the extract cited above was that "the taxpayer
must satisfy the Court that his or her bona fide
purpose in using the funds was to earn income."
The borrowed monies were not used by the taxpay
er to earn income from business or property like
they were under the business arrangement
described in Trans-Prairie. They were used to
finance the personal residence of the respondent.
I am not called upon to decide what would have
been the situation had the respondent used his
personal funds to pay off the mortgage, then
borrow monies for investment using his home as
collateral security. I express some difficulty how
ever with the contention of the respondent that the
difference between such an arrangement and the
present one would simply be one of form. But in
final terms, what was said by Dickson C.J. in
Bronfman Trust, governs the present case: ' 7
... the courts must deal with what the taxpayer actually did,
and not what he might have done: Matheson v. The Queen, 74
D.T.C. 6176 (F.C.T.D.) per Mahoney J., at p. 6179.
The case at bar is not one where the borrowed
monies can be traced to a specific eligible use.
The Sinha case cited by Dickson C.J. ' 8 and on
which the Trial Judge relied, represents an entirely
different factual situation from the case at bar.
There, a change occurred from the original pur
pose of the loan but the use to which the borrowed
money was put was an eligible one. The taxpayer
in question borrowed money as a Canada Student
Loan at an advantageous interest rate. He did not
15 Trans-Prairie Pipelines, Ltd. v. M.N.R., at p. 541.
16 Bronfman Trust, supra, at p. 52.
' 7 Bronfman Trust, supra, at p. 55.
18 Bronfman Trust, supra, at p. 47.
need the funds so he decided to invest them so as
to earn a profit. He deducted the interest expenses.
The Minister disallowed the deduction on the
ground that the funds, originally borrowed for
personal reasons retained that character during the
material time. The Tax Review Board held that
although the original purpose for which the loan
had been made had changed the use of the bor
rowed money during the year in question was used
to earn income and not to further the taxpayer's
education. The requirements of subparagraph
20(1)(c)(i) were met since the current use of the
borrowed money was an eligible one. 19
I would allow the appeal, set aside the decision
of the Trial Judge and restore the reassessments
made earlier by the Minister in which he disal
lowed the amounts claimed by the respondent as
interest deductions for the years 1980, 1981 and
1982, and as detailed supra.
In accordance with subsection 178(2) of the
Act, 2 ° I would order that the respondent be en
titled to his costs in the appeal.
19 Dickson C.J. in the same vein mentioned "Attaie (SM) v
MNR (1985), 85 DTC 613 (T.C.C.) (presently under appeal)".
Cited as it was, this could not be an approval of the decision of
the Tax Court. At the most, in context, it can only refer to the
uncontested part of the judgment which concerns itself with the
period the Attaie's house was used as a rental property.
20 Subsection 178(2) [as am. by S.C. 1976-77, c. 4, s. 64(1);
1980-81-82-83, c. 158, s. 58; 1984, c. 45, s. 75] of the Act, in
force when the appeal was filed (5 November 1987) read:
178. . . .
(2) Where, on an appeal by the Minister other than by
way of cross-appeal, from a decision of the Tax Court of
Canada, the amount of
(a) tax, refund or amount payable under subsection
196(2) (in the case of an assessment of the tax or determi
nation of the refund or the amount payable, as the case
may be) that is in controversy does not exceed $10,000, or
(b) loss (in the case of a determination of the loss) that is
in controversy does not exceed $20,000,
the Federal Court, in delivering judgment disposing of the
appeal, shall order the Minister to pay all reasonable and
proper costs of the taxpayer in connection therewith.
HEALD J.A.: I agree.
STONE J.A.: I agree.
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.