23 February 2004 External T.I. 2003-0044255 - INTEREST DEDUCTIBILITY INSURANCE POLICY

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.

Principal Issues: Will interest paid at 10% to earn income of 8% be deductible

Position: Not if draft legislation is passed

Reasons: Proposed amendments to ITA

		2003-004425
XXXXXXXXXX 	Denise Dalphy, LL.B.
(613) 941-1722
February 23, 2004

Dear XXXXXXXXXX:

We are writing in reply to your facsimile transmission of October 17, 2003 wherein you asked for our views on the deductibility of interest paid on certain universal life policy loans.

Our Comments

Written confirmation of the consequences 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 70-6R5. Nonetheless, we shall provide some comments of a very general nature and we enclose a copy of Interpretation Bulletin IT-533, Interest Deductibility and Related Issues, dated October 31, 2003, for your information.

Paragraph 20(1)(c) of the Act permits the deduction of an amount paid in the year or payable in respect of the year, pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property. The Canada Revenue Agency (the "CRA") has always been of the view that the proper interpretation of the Income Tax Act was that interest is generally only deductible if, inter alia, there was a reasonable expectation of net profit from the investment.

However, in September 2001, the Supreme Court of Canada, in the case of Ludco Enterprises Ltd. et al. v. The Queen, [2002] 2 CTC 95, 2001 DTC 5505 (SCC), reversed the decisions of the lower courts (which had in general terms supported the interpretation of the CRA) and stated that: "...it is clear that 'income' in s. 20(1)(c)(i) refers to income generally, that is an amount that would come into income for taxation purposes, not just net income." The court also said, "The plain meaning of s. 20(1)(c)(i) does not support an interpretation of `income' as the equivalent of `profit' or `net income' ....".

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."

On October 31, 2003, the Department of Finance released a Media Release (a copy of which is enclosed), which included draft legislation regarding interest deductibility.

The Media Release stated:

"...The proposed legislative amendments and draft interpretation bulletin are aimed at clarifying how the income tax system links the deductibility of certain expenses and losses to a taxpayer's prospects for profit, objectively determined. The proposals include specific Income Tax Act rules that require that there be a "reasonable expectation of profit" from a business or property for a taxpayer to realize a loss from the business or property, and that make clear that profit in this sense does not include capital gains...."

Accordingly, if the aforementioned draft legislation is enacted, for taxation years beginning after 2004, interest payable at 10% on amounts borrowed in order to invest in properties that will generate 8% income will not be deductible for income tax purposes.

The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of Information Circular 70-6R5, the above comments do not constitute an income tax ruling and accordingly are not binding on the CRA. Our practice is to make this specific disclaimer in all instances in which we provide an opinion.

Yours truly,

Steve Tevlin
Manager
Corporate Financing Section
Financial Industries Division
Income Tax Rulings Directorate