Marie-Eve Gosselin, Paul Lynch, "A Review of Interest Deductibility Since Ludco", 2015 CTF Annual Conference paper

Purpose test not an anti-avoidance tool (p.7:10)

Novopharm can be seen as confirmation that the purpose test in subparagraph 20(l)(c)(i) cannot be used by the courts as an anti-avoidance tool-- that is, to defeat plans that are motivated by tax avoidance…[I]n Novopharm, the sole objective of the transactions, when viewed as a whole, was tax avoidance. Nevertheless, the Federal Court of Appeal allowed the interest deduction under subparagraph 20(1)(c)(i).

Swirsky - profitable company with no policy of not paying dividends (p.7:12)

[I]t is the end result in Swirsky that is difficult to absorb in light of the facts reported. When shares of a profitable corporation are acquired with borrowed funds, unless the company has a clear policy against paying dividends, taxpayers should not have to go out of their way to establish some specific expectation of dividend income. …

CRA challenges to intercompany interest charges (p.7:18)

We have seen challenges [to the reasonableness of the interest rate] in related groups, between sister companies, parents and subsidiaries, and cross border hybrid debt structures. The CRA is using its valuation experts to prepare an analysis of the reasonableness of the interest rate. We have seen significant reductions to interest rates claimed to nominal amounts and in some cases zero. Valuation is not an exact science, and frequently mid-range values become the settlement zone. As a practice point, undertaking some type of interest rate analysis, but not necessarily a full valuation, is useful evidence.

Adjustment to recipient's interest inclusion (p. 7:18-7:19)

A second problem with such adjustments is that they are one-sided. If the debt is within the group, interest expense could be denied, yet the interest income would remain fully taxable.

In some instances, we have seen CRA apply a policy first outlined in 1986 at the Canadian Tax Foundation's Annual Conference [in response to Question 39] to reduce interest income of the recipient entity. ... This position was confirmed as valid in a CRA technical interpretation. [f.n. 45...2012-0440071E5.]

Interest deduction following share redemption in exceptional circumstances (p.7:20)

5) In the case of a redemption of shares, the interest expense will generally not be deductible because the direct-use requirement for the borrowed funds will not be met; instead, the corporation must be able to show exceptional circumstances or otherwise rely on the fill-the-hole theory to support its interest deduction;

6) When a redemption of shares occurs in the context of a shareholder dispute, exceptional circumstances can be demonstrated if the corporation submits detailed evidence to show the detrimental impact of the dispute on its day-to-day operations and how the redemption had the effect of preserving or improving the company's income-earning capacity;

CRA challenges to intercompany interest charges (p.7:18)

We have seen challenges [to the reasonableness of the interest rate] in related groups, between sister companies, parents and subsidiaries, and cross border hybrid debt structures. ... We have seen significant reductions to interest rates claimed to nominal amounts and in some cases zero.

Adjustment to recipient's interest inclusion (p. 7:18-7:19)

A ... problem with such adjustments is that they are one-sided. If the debt is within the group, interest expense could be denied, yet the interest income would remain fully taxable.

In some instances, we have seen CRA apply a policy first outlined [in response to Question 39 of the Revenue Canada Roundtable] in 1986 at the Canadian Tax Foundation's annual conference to reduce interest income of the recipient entity. ... This position was confirmed as valid in a CRA technical interpretation. [f.n. 45...2012-0440071E5.]