1 March 2000 External T.I. 1999-0014975 - ATTRIB. RULES - INTEREST DEDUCTION

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Where an individual transfers shares to his or her spouse that have an acb of $1 and fmv of $100,000 and an amount is borrowed by the spouse from a bank to pay and the individual in turn pays off a personal residence mortgage, do the attribution rules apply and is the interest deductible?

POSITION TAKEN:

Attribution Rules apply but the interest is probably not deductible

Reasons FOR POSITION TAKEN:

74.5(11), GAAR, Robitaille v The Queen 97 DTC 1286

XXXXXXXXXX 1999-001497
C. Tremblay
Attention: XXXXXXXXXX

March 1, 2000

Dear XXXXXXXXXX:

This is in reply to your letter of December 13, 1999, wherein you seek our comments with regards to the following situation. The facts given are as follows:

1. Mrs. A owns shares of a corporation that have an adjusted cost base ("ACB") of $1. The fair market value ("FMV") of the shares are $100,000. The corporation does not qualify as a small business corporation as defined in subsection 248(1) of the Income Tax Act (the "Act").

2. Mrs. A has a mortgage on her home of $100,000.

3. Mrs. A sells the shares of the corporation to her husband ("Mr. A" ) and does not elect out of subsection 73(1) of the Act. The adjusted cost base of the shares to Mr. A is $1. The sale of shares is deemed to have occurred at $1.

4. Mr. A borrows from a bank $100,000 to pay for the shares.

5. Mrs. A uses the $100,000 proceeds to pay off her personal mortgage.

In your view, the results are as follows:

1. No gain or loss will be reported on the sale of shares.

2. Future dividends will be paid to Mr. A.

3. Because of the attribution rules, the dividends and the dividend tax credits should be reported by Mrs. A.

4. Any future capital gains will be reported by Mrs. A.

Our Comments:

The situation described in your letter appears to be an actual fact situation and written confirmation of the tax implications inherent in proposed transactions are given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R3. Where a completed transaction is involved the enquiry should be addressed to your local Tax Services Office. Consequently, we can only offer the following general comments.

Subsection 73(1) of the Act provides that where an individual transfers capital property to his/her spouse and both are resident in Canada at the time of the transfer, the particular property transferred shall be deemed to have been disposed of for proceeds equal to the ACB of the property immediately before the transfer and to have been acquired by the individual's spouse for an amount equal to those proceeds. Accordingly, if the transferor does not elect out of the provisions of subsection 73(1) of the Act, he/she is not required to report any capital gains resulting from the sale of the property to their spouse. However, pursuant to subsection 74.1(1) and 74.2(1) of the Act and subject to subsection 74.5(11) of the Act, any dividends or other income from the property after the sale to the spouse, will be deemed to be the transferor's income and any capital gains or losses realized on the subsequent disposition of the property will be deemed to be the transferor's capital gains or losses. In this regard, income from property would generally be the income after deducting those expenses that are deductible in computing income from that particular property. Finally, subsection 82(2) of the Act provides that where a dividend is included in the transferor's income because of the attribution rules, the dividend is deemed to have been received by the transferor. This will enable the transferor to claim the dividend tax credit.

Interest expense would be deductible in computing income if certain conditions set out in paragraph 20(1)(c) of the Act are met. With respect to the deductibility of interest expense, it is the Agency's position that it is the current use of the funds which must satisfy the eligible purpose test, since paragraph 20(1)(c) of the Act establishes the requirement to trace the use of the funds. Accordingly, it is not the purpose of the borrowing but rather the purpose of the use of the funds which is looked at when determining whether the criteria of paragraph 20(1)(c) of the Act is met.

Generally, where a taxpayer uses borrowed money to repay money previously borrowed, or to repay an amount for previously acquired property, pursuant to subsection 20(3) of the Act, the borrowed money will be treated as having been used for the same purpose as the original borrowing, or having been used to acquire the same property as the case may be. It is a question of fact whether borrowed money was used to repay money previously borrowed or was used to acquire an income producing asset.

Even though you have not requested our comments with respect to paragraph 20(1)(c) of the Act or GAAR, should you wish to receive definitive comments on these provisions with respect to a proposed transaction similar to the one described herein, we suggest that you request an advance income tax ruling submitted in the manner set out Information Circular IC 70-6R3.

We trust our comments are of assistance.

Your truly,

Jim Wilson
for Director
Business and Publications Division
Income Tax Rulings Directorate
Policy and Legislation Branch

- 3 -