12 February 2002 External T.I. 2001-0081025 - 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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

1. Whether interest continues to be deductible if a portion of the investment is sold and the proceeds are used to pay down the principal of the loan.

2. Whether interest on borrowed money used to purchase equity mutual funds or common shares, continues to be deductible as opined in our technical interpretation 2000-0036435.

Position:

1. Yes
2. Yes

Reasons:

1. If the remaining borrowed funds continue to be put to an eligible use, the interest expense relating to the remaining balance of the Loan will continue to be deductible provided that the interest paid satisfies all the conditions in paragraph 20(1)(c)
2. Our position remains unchanged from that stated in our technical interpretation 2000-0036435.

XXXXXXXXXX 2001-008102
N. L. Storry
February 12, 2002

Dear XXXXXXXXXX:

Re: Paragraph 20(1)(c) of the Income Tax Act (Canada) (the "Act")

We are writing in response to your correspondence of April 23, 2001, wherein you requested our views on whether interest on borrowed funds used for the purpose of earning income from property is deductible where some of the leveraged investment is withdrawn by the individual.

Briefly, you have described a situation where an individual borrows money from a financial institution (the "Loan") and uses the proceeds of the Loan to acquire shares or mutual fund units (the "securities"). Subsequently, the individual disposes of some of the securities in order to pay the interest expense or to pay down the principal of the Loan. You have asked whether interest on the Loan is deductible and whether the disposition of a portion of the securities would reduce the amount of the interest paid or payable on the Loan that would be deductible pursuant to paragraph 20(1)(c) of the Act.

The situation outlined in your letter involves an actual fact situation. To the extent that it relates to a past transaction you should contact the appropriate Tax Services Office ("TSO") of the Canada Customs & Revenue Agency (the "CCRA"). Since the review of such transactions falls within the responsibility of the TSO, it is the practice of the Income Tax Rulings Directorate not to comment on such transactions. In the case of a proposed transaction, assurance as to the tax consequences of actual proposed transactions will only be given in the context of an advance income tax ruling. However, we can offer the following general comments.

Our Comments

Generally, interest on borrowed funds is deductible for purposes of the Act if it meets all the requirements of paragraph 20(1)(c) of the Act. Paragraph 20(1)(c) of the Act provides notably that the money must have been borrowed for the purpose of gaining or producing income from a business or property. It is the current use of the borrowed funds in a particular year rather than the initial use of the funds, which must be considered in determining whether the interest paid or payable with respect to the borrowed funds is deductible in the particular year.

On the assumption that interest on borrowed money used to purchase certain securities is initially deductible, you have asked whether interest expense continues to be deductible if a portion of the securities is disposed of to pay down the principal amount of the loan.

Where a portion of the securities is disposed of and the proceeds are used to pay down the principal amount of the Loan, such a repayment will also reduce the outstanding balance of the Loan thereby reducing the interest payable. If the remaining borrowed funds continue to be put to an eligible use, the interest expense relating to the remaining balance of the Loan will continue to be deductible provided that the interest paid satisfies all the conditions in paragraph 20(1)(c).

You have asked whether interest on borrowed money used to purchase equity mutual funds or common shares continues to be deductible as opined in our technical interpretation 2000-0036435. Our existing position remains unchanged from that stated in our reply to the above-mentioned technical interpretation.

However, we are currently in the process of reviewing our existing positions on interest deductibility subsequent to the recent decisions of the Supreme Court of Canada on interest deductibility. You may wish to contact us subsequent to the completion of our study to confirm our positions at that time.

We trust these comments will be of assistance.

Yours truly,

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