24 October 2000 Internal T.I. 2000-0048177 - DEDUCTIBILITY OF INTEREST ON ASSUMED DEBT

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: Deductibility of interest on debt assumed by a corporation as proceeds on the redemption of its preferred shares

Position: Not deductible

Reasons: No money borrowed (20(1)(c)(i) by the corporation and no property acquired as required by 20(1)(c)(ii).

		October 24, 2000

	VANCOUVER TSO	HEADQUARTERS
J. P. Dunn
	Attention: Edith Chmielnicki	(613) 957-2747
	                 Professional and Business Enquiries             

		2000-004817

Deduction of Interest Payable on Assumed Debt

We are writing in response to your facsimile correspondence of September 21, 2000 regarding the deductibility of interest payable on assumed debt. In the situation under consideration , a corporation redeems certain of its preferred shares and, as consideration for the redemption, assumes a bank loan owed by the redeeming shareholder. The shareholder had previously borrowed funds from the bank to purchase business assets which assets were subsequently transferred to the corporation. The liability for the loan, however, remained with the shareholder subsequent to the asset transfer until assumed by the corporation as described. You have requested our views as to whether the interest on the assumed debt would be deductible by the redeeming corporation pursuant to paragraph 20(1)(c) of the Act.

Subparagraph 20(1)(c)(i) of the Act allows a deduction for interest on borrowed money used for the purpose of earning income from a business or from property. In the present case, although there does exist borrowed money, it is the shareholder and not the redeeming corporation which has borrowed that money. Because there exists no lender/borrower relationship between the bank and the redeeming shareholder as is required by this subparagraph, the interest is not deductible to the corporation by virtue thereof.

With respect to subparagraph 20(1)(c)(ii) of the Act, the assumption of the bank debt by the redeeming corporation would be considered to be an "amount payable", as that phrase is used in the provision. That provision, however, only allows a deduction for interest in circumstances in which the "amount payable" is in respect of "property acquired for the purpose of gaining or producing income from the property". As there has been no property acquired by the corporation upon the redemption of its preferred shares, the interest on the assumed debt is not deductible pursuant to subparagraph 20(1)(c)(ii).

Accordingly, under the circumstances, the interest on the assumed debt does not qualify for a deduction pursuant to paragraph 20(1)(c) of the Act. We do, however, recognize that if the corporation had assumed the debt upon the acquisition of the business assets from the shareholder and had continued to use those assets for the purpose of earning income from a business or from property, the interest on the debt would be considered to be deductible. While we understand that the manner in which the transactions were undertaken may have been legitimately motivated, we are not able to ignore the income tax results which flow therefrom.

We trust that this is the information which you require.

for Director
Financial Industries Division
Income Tax Rulings Directorate