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.
Summary Sheet
Principal Issues:
Interest deductibility where borrowed money was originally used to acquire investments and a portion of the investments are subsequently disposed of.
Position TAKEN:
Interest is deductible only for so long as the borrowed money continues to be used for a qualifying purpose.
Reasons FOR POSITION TAKEN:
In a situation where the investment has increased in value, when the property is disposed of and not replaced with another income earning property, the use test in paragraph 20(1)(c) is no longer met. Therefore, the interest attributable to the money originally borrowed to acquire the property disposed of is no longer deductible.
XXXXXXXXXX 2001-008524
Yves Leclerc
September 12, 2001
XXXXXXXXXX:
Subject: Interest Deductibility
This is in reply to your letter received May 22, 2001 in which you requested our views on interest deductibility under paragraph 20(1)(c) of the Income Tax Act (the "Act") in two situations. We will answer your questions in the order that they were submitted, however, our comments will be general considering these are hypothetical questions.
As stated in your letter, we are assuming that interest incurred on money borrowed to make the initial investment is deductible under paragraph 20(1)(c) of the Act.
Situation # 1
With respect to your first situation, you mentioned that the initial unit investment has increased in value over the years by 50% and a decision is taken to dispose of a portion of it. The initial unit investment has been financed in its entirety. The interest expenses incurred up to the disposition were deductible under paragraph 20(1)(c) of the Act.
Generally, when a taxpayer has disposed of property acquired with borrowed funds, unless the proceeds attributable to the borrowed money used to make the original investment are subsequently used for a qualifying purpose, the deduction for interest on those borrowed funds is no longer available under paragraph 20(1)(c) of the Act. To be eligible for a deduction under paragraph 20(1)(c), the borrowed money must continue to be used for the purpose of earning income.
In the above example, it is our view that 100/150 of the proceeds of disposition are representative of the borrowed money which was used to make the original unit investment. Accordingly, if such portion of the proceeds is not subsequently used for a qualifying purpose, the interest on that portion of the borrowed money would no longer be deductible.
Situation # 2
In the second situation, you stated that following the initial unit investment which was purchased with borrowed money, income distributions have occurred over the years equating to a 50% return on the initial investment. These income distributions were re-invested in additional units. At this point in time, the investor wants to extract the 50% growth for personal use and therefore disposes of 1/3 of the units. For purpose of this situation, we assume that the income distributions made to the investor have been included into his/her income over the years.
In the above example, since the investment units would be homogeneous, it would generally be assumed that the units disposed of would be comprised of units which were acquired with borrowed money in the proportion of 2/3 and units acquired with reinvested distributions in the proportion of 1/3. Assuming that the original units have not appreciated in value, 2/3 of the proceeds of disposition could reasonably be considered attributable to the money borrowed to make the original investment. Accordingly, it is our view that as such borrowed money is no longer being used to earn income, the interest on such portion of the borrowed money would not be deductible subsequent to the disposition.
We trust that our comments will be of assistance to you.
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy & Legislation Branch
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