The taxpayers owed approximately $2.7 million on mortgage loans including substantial amounts of interest that previously had been agreed to be deferred and added to the amount of the mortgage. The mortgage loan was restructured so that the taxpayers became obligated to make annual minimum interest payments of $20,000 for each of the first 15 years following the restructuring and had the right at any time within the 15-year period to discharge all amounts on the loan by the payment of the sum of $100,000 plus all of the unpaid interest payments of $20,000 per annum. The restructuring of the loan was stated to be in the form of a refinancing of a portion of the previous mortgage debt on the terms indicated above, with a statement that these amendments did not have the effect of discharging or novating the previous mortgage obligation. For the taxation years in question following the restructuring, the taxpayers sought to deduct unpaid interest amounts that continued to be added to the original amount of the mortgage loan, namely, $154,373, $160,254 and $168,782. The trial judge disallowed the deductions on the basis that they were not "payable" in the year if they were not required to be paid in the year.
The Court of Appeal found that such unpaid interest amounts were deductible in the years of accrual. The taxpayers computed their income on an accrual basis, under which "payable" does not mean "required to be paid." Sharlow J.A. stated (at paras. 24-25):
They are entitled to that deduction even though they were not obliged to pay the full amount of the interest in the year of accrual, and even though the lender would be obliged, if the appellants exercised the settlement option, to forgive most of the obligation to pay principal and interest.
The situation is analogous to that of a limited recourse mortgage loan, where the right of the lender to recover the principal and interest is limited to the proceeds of the sale of the mortgaged property at the end of the term. Even if it is absolutely certain that the value of the property will not cover the mortgage debt, the full amount of the debt remains a legal obligation of the borrower unless and until the mortgaged property is sold.