9 October 2015 APFF Roundtable Q. 1, 2015-0595751C6 F - Deductibility of financing fees and 20(1)(e)(v) -- translation

Principal Issues: Can the remaining balance of financing fees be written off in a taxation year where the borrowing to which they relate is extinguished, in four different scenarios?

Position: Only in the first scenario.

Reasons: Scenarios two to four would all be part of a series of borrowings or other transactions and repayments.

9 OCTOBER 2015 FEDERAL TAX ROUNDTABLE
2015 APFF CONFERENCE

Question 1

Deductibility of the balance of the borrowing costs referred to in paragraph 20(1)(e) of the Act On the transfer of building in favour of a corporation.

On January 1, 2013, an individual borrows an amount of $1,000,000 that he uses to purchase a rental property with a fair market value ("FMV") of $1,250,000. At that time, he incurs an expense of $10,000 related to mortgage guarantee fees.

Guarantee fees for borrowing from an arm's-length person are deductible in accordance with paragraph 20(1)(e).

On January 1, 2015, the individual transfers the rental property to a corporation controlled by him (“Realtyco"). At that time, the FMV of the property is $1,400,000 and the balance of the mortgage is $900,000. As no capital cost allowance has been claimed for the building, the cost of the land and building is still $1,250,000. The balance of the guarantee fees not yet deducted is $6,000.

A subsection 85(1) election is made respecting the land and building. The agreed amount is $1,250,000.

Where in a taxation year all debt obligations in respect of a borrowing or indebtedness are settled or extinguished (otherwise than in a transaction made as part of a series of borrowings or other transactions and repayments) by the taxpayer, the balance of expenses that could not be deducted in a prior year because of the five-year allocation rule becomes deductible for the particular taxation year under subparagraph 20(1)(e)(v). However, this subparagraph applies only if the taxpayer settles or extinguishes all claims for consideration that do not include any unit, interest, share or debt obligation of the taxpayer or any person with whom the taxpayer does not deal at arm’s length or any partnership or trust of which the taxpayer or any person with whom the taxpayer does not deal at arm’s length is a member or beneficiary.

Questions to the CRA

Could the CRA confirm that the balance of expenses that could not be deducted in a previous year because of the five-year allocation rule becomes deductible for the 2015 taxation year in each of the following situations:

1. On the transfer, the individual receives $150,000 in Realtyco preferred shares and $1,250,000 paid out of liquid assets on hand accumulated out of past earnings.
2. On the transfer, the individual receives $150,000 in Realtyco preferred shares and $1,250,000 borrowed by Realtyco from a financial institution without a personal guarantee.
3. On the transfer, the individual receives $150,000 in Realtyco preferred shares and a demand promissory note for $350,000, and Realtyco assumes a mortgage for $900,000 without the financial institution lender requiring a personal guarantee.
4. Would the answer be different for questions (b) or (c) if the financila institution required a personal guarantee of the individual?

CRA response

When certain conditions are satisfied, subparagraph 20(1)(e)(ii) permits the deduction, over a period of five years, of expenses incurred in the course of a borrowing of money used for the purpose of earning income from a business or property. However, by virtue of subparagraph 20(1)(e)(ii), in the case of all debt obligations in respect of the borrowing of money which are settled or extinguished (otherwise than in a transaction made as part of a series of borrowings or other transactions and repayments) in the course of a taxation year by the taxpayer for consideration that does not include shares or debt obligations of the taxpayer or any person with whom the taxpayer does not deal at arm’s length, the portion of the expenses which was not deductible in the prior years under subparagraph 20(1)(e)(ii) can be deducted in such taxation year.

1. Your first example appears to be a situation where the conditions of subparagraph 20(1)(e)(v) would be respected as it is our understanding that the loan is entirely repaid by the individual with the proceeds of disposition of the rental property which are derived from the liquid assets of the corporation. However, the other facts surrounding the transaction must demonstrate that the repayment is not part of a series of loans or other transactions and repayments.
2. In your second example, although the debt of the individual is extinguished, in our view the extinguishing of this obligation forms part of a series of loans and other transactions or repayments as a related corporation borrows a comparable amount as part of the series of transactions.
3. In your third example, although it appears that the debt of the individual is extinguished (as we are assuming that that the lender releases the individual thereunder), in our view the extinguishing of this obligation forms part of a series of loans and other transactions or repayments, as a related corporation assumes the debt of the individual as part of the series of transactions.
4. The fact that the shareholder acts as surety for the corporation’s debt would not change our responses to the second and third examples.

Yves Grondin
2015-059575