15 May 2003 External T.I. 2003-0006265 - AMOUNT PAYABLE FOR SUBSTITUTED PROPERTY

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:

Whether, interest paid in the year or payable in respect of the year on debt assumed as partial or full consideration for an income source (the "first income source") will continue to be deductible where the first income source is disposed of, a new income source is acquired and the balance of the debt assumed is reflected in the cost of the new income source.

Position TAKEN:

Yes.

Reasons FOR POSITION TAKEN:

Permitted by operation of subparagraph 20(1)(c)(ii) provided the other requirements of paragraph 20(1)(c) are met.

Moreover, CCRA's published positions [see 1984 CTF # 18, 1992 CMTF # 3, 1992] should also apply in similar circumstances where, in lieu of borrowed money, a debt is assumed to acquire the first income source.

XXXXXXXXXX 							2003-000626
P. Diguer
May 15, 2003 

Dear XXXXXXXXXX:

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

This is in reply to your facsimile dated March 6, 2003, in which you request our views on the application of the Act in regards to the deductibility of interest pursuant to subparagraph 20(1)(c)(ii) of the Act.

In particular, you describe a situation where:

A taxpayer purchases an income producing property for $100. The taxpayer satisfies the purchase price in full by assuming an interest bearing debt (the "Debt") owed by the vendor to a third party (the "Debt") that has a balance owing of $100. Over time the income producing property increases in value to $120 and the taxpayer pays interest on the Debt but pays no principal.

The taxpayer then transfers the income producing property to a partnership for $120. The partnership satisfies the purchase price by making a $20 cash payment and issuing a partnership interest for the $100 balance. The taxpayer's purpose for acquiring the interest in the partnership is to earn income. The taxpayer uses the $20 cash payment received from the partnership for a non-income producing purpose.

The issue is whether all of the interest on the Debt would continue to be deductible after the taxpayer transfers the income producing property to the partnership.

Our comments

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 matter of an advance ruling request submitted in the manner set out in Information Circular IC 70-6R5 dated May 17, 2002. Where the particular transaction is completed, the inquiry should be addressed to the relevant Tax Services Office. Although we are unable to provide any opinion in respect of the specific transactions described in your letter, we have set out some general comments which we hope are of assistance to you.

Subparagraph 20(1)(c)(ii) of the Act applies to interest on an amount payable for property acquired for the purpose of gaining or producing income. In our view, determining that there is an "amount payable" is a lower threshold than the determination of "borrowed money" as is required under paragraph 20(1)(c)(i) of the Act and thus most financing arrangements that do not qualify as "borrowed money" would generally fit the "amount payable" category. This would include situations where a taxpayer has assumed another person's indebtedness as part of the purchase price of an asset acquired by the taxpayer. Although, unlike subparagraph 20(1)(c)(i), there is no "use of borrowed money" test in subparagraph 20(1)(c)(ii), where a property referred to in subparagraph 20(1)(c)(ii) of the Act is disposed of, the substituted property will be relevant for the continuing application of that subparagraph.

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."

Yours truly,

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