16 May 2000 External T.I. 2000-0005125 - INTEREST EXPENSE ATTRIBUTION

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:

1. Transferor spouse borrows funds to acquire shares. Shares transferred to spouse for no consideration. No 74.5(1) election. Is interest deductible?

2. Does 20.1 apply?

Position:

1. No

2. Depends

Reasons:

1. Shares have been disposed of and no consideration received.

2. Depends on fair market value of shares at time of disposition.

XXXXXXXXXX 2000-000512
J. P. Dunn
Attention: XXXXXXXXXX

May 16, 2000

Dear Sirs:

Re: Interest Deductibility and the Income Attribution Rules

We are writing in response to your correspondence of January 28, 2000 in which you had requested the views of Canada Customs and Revenue Agency with respect to a situation in which a transferor spouse transfers investment property consisting of "flow-through shares" to a transferee spouse for no consideration. The transferor spouse had previously borrowed funds from an arm's length party to finance the acquisition of those shares.

Also, because the transferor spouse does not elect pursuant to subsection 74.5(1) of the Income Tax Act (the "Act"), subsection 73(1) of the Act is applicable such that that the investment property is disposed of by the transferor and acquired by the transferee at the adjusted cost base of that property to the transferor spouse. Furthermore, because no election pursuant to subsection 74.5(1) of the Act is made, the provisions of subsections 74.1(1) and (2) of the Act are applicable to attribute any income from or gains derived on the investment property to the transferor spouse.

You have requested whether, in such circumstances, interest on the funds borrowed by the transferor spouse to acquire the transferred shares would continue to be deductible by that spouse subsequent to the transfer because any income from such shares would be attributed to that spouse pursuant to subsection 74.1(1) of the Act.

Generally, when a taxpayer has disposed of property acquired with borrowed funds, the deduction for interest on those borrowed funds pursuant to paragraph 20(1)(c) of the Act is no longer available. This would include the situation in which the property is disposed of to a spouse and the income earned from the property is attributed back to the taxpayer.

Subsection 20.1 of the Act may be applicable in some situations in which the property has been so disposed of. When the property is disposed of for consideration which is less than the fair market value of the property, the excess of the amount of the borrowed money over the fair market value of the property at the time of disposition will be deemed to be used for the purpose of earning income and, consequently, the interest expense on that excess amount will continue to be deductible pursuant to paragraph 20(1)(c) of the Act.

We trust that this is the information which you require.

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