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) An investor borrows money and purchases a unit of a trust for $10.00. The distribution policy of the trust is to make annual cash distributions of $.80 per unit regardless of income earned by the trust. The trust earns $.50 per unit and the unitholder receives a distribution of $.80 per unit. At the end of the year, the unit value is $9.70. The return of capital of $.30 is used for personal use. Is the interest related to the return of capital still deductible under paragraph 20(1)(c)?
2) An investor purchases a unit of a real estate investment trust for $10.00. The investor receives a cash distribution of $.80. The REIT's income for tax purposes is $.50. Is the $.30 a return of capital to the investor?
Position TAKEN:
1) No.
2) Yes.
Reasons FOR POSITION TAKEN: With respect to the return of capital from the trust to the individual, the current use of that portion (the return of capital) of the borrowed funds is for personal use and therefore, any interest relating to borrowed money used for personal use is not deductible under paragraph 20(1)(c). See 2002-0142475, 9511817, 9326621, 9726133, 2001-0081025, 2001-0110455,
XXXXXXXXXX 2003-000082
G. Moore
May 13, 2003
Dear XXXXXXXXXX:
Re: Interest Deductibility
This is in reply to your letter of January 30, 2003, regarding interest deductibility with respect to money borrowed to invest in units of a trust.
You are asking for our views in the following situations:
Scenario 1
An investor borrows $10 and invests it in units of a trust. The trust makes annual cash distributions of $.80 per unit regardless of the income earned by the trust. The trust earns $.50 per unit and the investor receives a distribution of $.80 per unit. At the end of the year, the unit value is $9.70. The return of capital of $.30 is used by the investor for personal use. You are enquiring as to whether the full amount of the interest on the borrowed money is deductible under paragraph 20(1)(c) of the Income Tax Act (the "Act").
Scenario 2
An investor purchases a unit of a real estate investment trust ("REIT") for $10. The investor receives a cash distribution of $.80, which represents the REIT's net income before capital cost allowance. After claiming capital cost allowance, the REIT's income for tax purposes is $.50. Is the $.30 considered a return of capital to the investor?
It is your view that, for purposes of interest deductibility, not every distribution by a trust should be viewed as a return of capital which reduces the adjusted cost base of an investor's units pursuant to subparagraph 53(2)(h)(i.1) of the Act.
Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject of an advance income tax ruling request submitted in a manner set out in Information Circular 70-6R5. As stated in paragraph 22 of Information Circular 70-6R5, written opinions are not advance tax rulings and, accordingly, are not binding on the Agency. The following comments are, therefore, of a general nature only.
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 made 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. In order to determine whether borrowed funds have been put to an eligible use, it is necessary to determine the current use of the original borrowed funds.
We would draw your attention to our response to Q.18 at the 1984 Canadian Tax Foundation Revenue Canada Round Table, in which we stated:
"It is the Department's position, supported by several cases, including Trans-Prairie Pipelines Ltd. v. MNR, 70 DTC 6351, that interest sought to be deducted under paragraph 20(1)(c) of the Act must relate to a business or property income source. This requirement will not be satisfied in circumstances where the income source ceases to exist, is transferred, or changes use (for example, where a rental property becomes the owner's personal residence). Where one income source is disposed of and the proceeds are used to acquire another income source, interest on the borrowed money that was used to acquire the first income source will continue to be deductible to the extent that the borrowing is reflected in the cost of the new income source."
This position has been confirmed numerous times over the years. For example, please refer to our response to Q.20 at the 1987 Corporate Management Tax Conference Report. Also note the Supreme Court of Canada decision in The Queen v. Phyllis Barbara Bronfman Trust, 87 DTC 5059, where it was confirmed that it is the current use made 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 a particular year.
Scenario 1
We agree that of the annual cash distribution of $.80 to the investor, $.30 would be a return of capital to the investor. Where there is a return of capital to the owner of the units of a trust (without any disposition of any portion of the property), it may be appropriate to consider that the income-earning purpose may not be met with regard to such returned capital. Whether a distribution from a trust is a return of capital would require a determination which would depend on the facts of each particular situation. When distributions from a trust involve a return of capital to the owner of the trust unit, the current use of the borrowed money with regard to such returned capital would need to be determined, with the other requisite interest deductibility tests applied to such use.
In this example, we assume that the return of capital of $.30 by the trust to the investor is not used for an income-earning purpose but for personal use. If this is the case, it is our view that the interest on that portion of the borrowed money that relates to the return of capital from the trust would not be deductible since its current use is personal and not for an income-earning purpose.
Scenario 2
A distribution by a trust to a unitholder that is a return of capital reduces the adjusted cost base of a unitholder's units pursuant to subparagraph 53(2)(h)(i.1) of the Act. Whether a distribution from a trust is a return of capital would depend upon the facts of each particular situation. Where there is a return of capital to a unitholder of units of a trust (without a disposition of any portion of the property), the income-earning purpose may not be met with regard to such returned capital. The current use of the borrowed money with regard to such returned capital would need to be determined, with the other requisite interest deductibility tests applied to such use.
The income for tax purposes earned by the REIT is $.50. If an annual cash distribution of $.80 is made to a unitholder, $.30 would be a return of capital to the unitholder. We assume that the return of capital of $.30 by the trust to the unitholder is not used for an income earning purpose but for personal use. If this is the case, the interest on that portion of the borrowed money that relates to the return of capital from the trust would not be deductible since its current use is personal and not for an income-earning purpose.
On February 18, 2003, as part of the presentation of the Federal budget, the Department of Finance published the following statement concerning the deductibility of interest:
"Recent court decisions have raised uncertainties as to how taxpayers are to treat expenses, in particular interest, in computing income from a business or property for purposes of the Income Tax Act. Most notably, these decisions could lead to inappropriate tax results where a taxpayer derives a tax loss by deducting interest expenses, even if under any objective standard there is no reasonable expectation that the taxpayer would earn any income (as opposed to capital gains), or where the presence or the prospect of revenue (as opposed to income net of expenses) is enough to conclude that an expenditure was incurred "for the purpose of earning income".
Neither of these results is consistent with appropriate tax policy, nor would they have been generally expected under prior law and practice. Therefore legislative amendments to the Income Tax Act will be considered in order to provide continuity in this important area of the law. Before finalizing any proposals, however, the Department of Finance will release them for public consultation, with a general goal of ensuring that they restore continuity with the expected consequences before these recent court decisions."
We trust that the foregoing will be useful.
S. Tevlin
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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