Interest Deduction and the Attribution Rules
Swirsky v The Queen, 2014 FCA 36
This was an appeal from the decision in Swirsky v The Queen, 2013 TCC 73, where the TCC upheld the MNR’s denial of interest deductions from interest attributed back to the taxpayer by operation of subsection 74.1(1). It was held that the interest expense was not incurred for the purpose of gaining or producing income from the shares purchased because of the historical matrix of the shares.
FACTS
Mr Swirsky transferred shares of this private company to his spouse in three transactions (1991, 1993, and 1995). Ms Swirsky borrowed money to purchase these shares, incurring loses for her due to the interest expense. Mr Swirsky deducted the losses from his income pursuant to subsection 74.1(1) of the Income Tax Act (ITA).
The MNR reassessed to deny the loses to Mr Swirsky on the basis that the money borrowed by Ms Swirsky was not for the purpose of earning income. Since the interest is not deductible, there are no losses to attribute back to Mr Swirsky.
ANALYSIS
Subsection 74.1(1) attributes income and loss on property transferred from one spouse to another back to the transferor spouse.
The TCC held that Ms Swirsky had no reasonable expectation of income from the shares, and as such was not entitled to deduct the interest on the loan used to obtain the shares.
The correct legal test of whether interest is deductible under subparagraph 20(1)(c)(i) of the ITA is whether the loan proceeds were used for the purpose of earning non-exempt income from business or property (see Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622). To ascertain the purpose or intention behind an action, a court must be guided by both objective and subjective manifestation of that purpose or intention (see Ludco Enterprises Ltd. v. Canada, 2001 SCC 62). The following objective manifestations of purpose were seen by the FCA and the TCC as demonstrating a non-income earning purpose:
- There was no evidence that the family corporation ever paid dividends prior to 1999
- Prior to the transactions, the appellant’s family was supported by shareholder loans paid by the family corporation. Those loans were later transformed into bonuses paid to the appellant. The bonuses were not related to shareholdings
- In the years immediately after the transactions, family expenses continued to be paid by the family corporation. Such payments were treated as loans to family members, regardless of whether they held shares in the corporation
- The family corporation did not have a dividend policy or plan in place to pay dividends on the shares after their acquisition by the appellant’s wife
- The loan transactions were set up so the appellant’s wife, as borrower, would never have to pay interest or carrying charges out of her own pocket
- It could be inferred that the appellant’s wife had a reasonable expectation of receiving a capital dividend. After 1999, the next dividend was paid in 2003