CRA reconfirms that receipt of a capital distribution on a share can result in a loss of interest deductions

Comments of CRA in IT-533, para. 31, indicate that where a taxpayer borrows at a negative spread (e.g., borrowing to acquire preferred shares with a dividend rate lower than the interest rate), the interest generally will be deductible in full.  However, CRA has also indicated that where there is a paid-up capital distribution on shares acquired with borrowed money, there will be a proportionate loss of the interest deduction to the extent that the capital distribution is used for personal purposes.  See 1993 A.P.F.F. Round Table, Q.3.

Both propositions have recently been confirmed.  The second proposition is somewhat questionable where the quantum of the capital distribution is not sufficient to significantly impair the income-producing potential of the shares in question.

Neal Armstrong.  Summary of 15 August 2012 T.I. 2012-0446741E5 under s. 20(1)(c).