10 June 1996 External T.I. 9611135 - LOSS OF SOURCE INTEREST DEDUCTIBILITY

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:

application of 20.1 to investment in limited partnership where the ACB of the partnership at the date of dissolution is lower than the original ACB

Position:

Depends on the reason for the decline in the ACB of the partnership interests

Reasons:

Section 20.1 requires tracing of the use of borrowed funds. If the decline in the ACB is a result of capital withdrawals by partners, 20.1 should not apply

XXXXXXXXXX 961113

Attention: XXXXXXXXXX

June 10, 1996

Dear Sirs:

Re: Section 20.1 of the Income Tax Act (the "Act")

This is in reply to your letter of March 26, 1996, wherein you requested an interpretation of the application of section 20.1 of the Act in a situation where borrowed money was used to acquire an interest in a partnership, the partnership is subsequently dissolved and the partners receive real property from the partnership in satisfaction of their partnership interest. In particular you enquire as to how the "amount of borrowed money used to acquire the consideration " for the disposition of partnership interest is to be determined.

Section 20.1 of the Act applies where, because of a loss of source of income resulting from a decline in value of certain capital property, borrowed money ceases to be used for an income earning process. The rules ensure that interest on such borrowed money will, in certain circumstances, continue to be deductible. Subsection 20.1(5) of the Act applies where a taxpayer has used the borrowed money to acquire an interest in a partnership and provides that, in this case, the borrowed money is to be considered to be used for the purpose of earning income from the partnership interest. The Technical notes to this section indicate that section 20.1 of the Act will apply in the same way to borrowed money used to acquire a partnership interest as it applies to borrowed money used to acquire shares in a corporation.

In the example that you have provided, the adjusted cost base (ACB) of the partnership interest at the date of dissolution of the partnership is lower than the original cost of the partnership interest and the FMV of the property received in satisfaction of the partnership interest is less than the original cost of the partnership interest. We assume that the FMV of the partnership interest is equal to the FMV of the property received from the partnership.

The determination as to whether interest is deductible under paragraph 20(1)(c) of the Act is based, in part, on tracing the use of borrowed money. If the decrease in the ACB of the partnership interest is attributable to drawdowns by the partners of capital from the partnership, the borrowed money is traceable to an ineligible use and the amount of the decrease is not considered to be lost because of a decline in value of property for purposes of section 20.1. If the decrease in the ACB of the partnership interest is a result of losses of the partnership, the amount of borrowed money used to acquire the consideration, for purposes of subparagraph 20.1(1)(b)(i) of the Act, will be based on the FMV of the property received in satisfaction of the partnership interest and the original cost of the partnership interest.

We trust our comments are of assistance to you but caution that, as noted in Information Circular 70-6R2, they are not binding on the Department.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch