20 March 2003 External T.I. 2003-0181605 - SHAREHOLDER LOANS INTEREST EXPENSE

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:

Is Interest deductible when borrowing to loan to the corporation by way of shareholder loan?

Position TAKEN: Depending on the circumstances
REASON FOR POSITION: 20(1)(c)

									2003-018160
XXXXXXXXXX 								C. Tremblay, CMA
(613) 957-2139
March 20, 2003

Dear XXXXXXXXXX:

Re: Interest deductibility

This is in reply to your electronic message of November 28, 2002, wherein you ask us to clarify certain comments made in our Interest Deductibility Presentation to the Canadian Tax Foundation on October 1, 2002 (the "discussion paper"). Specifically you ask where in the discussion paper is the issue of interest deductibility on loans to a corporation by way of shareholder loan addressed.

Our Comments:

Written confirmations of tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an Advance Income Tax Ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to provide the following comments.

In paragraph O of the discussion paper, the sentence beginning with, "Funds borrowed by a shareholder which are used to contribute surplus to a corporation are not used for either of these purposes. Thus, interest on borrowed money for such purposes is not deductible." is generally meant to refer to contributed surplus or other forms of capital contributions by a shareholder. Since most shareholder loans involve an interest free loan to a corporation, we direct you to paragraph M of the discussion paper.

M. Borrowing to make interest free-loans.

In such circumstances, the direct use of the borrowed money is ineligible since no income can be generated from the property acquired. Thus, interest on borrowed money to acquire such property is generally not deductible. However, in certain factual situations, a deduction may be available under the exceptional circumstances category. No comprehensive guidelines can be provided as to when such borrowing would qualify. However, we would generally accept the deduction of interest on borrowed money used to make an interest-free loan to a wholly-owned corporation (or in cases of multiple shareholders, where each shareholder makes an interest-free loan in proportion to their shareholdings) where the proceeds will be used by the corporation to produce income, thereby increasing the potential dividends to be received. Interest deductibility in other situations involving interest-free loans may also be warranted depending upon the particular facts of a given situation.

Accordingly, it is a question of fact whether an individual shareholder can establish an income earning purpose for a loan made to his\her corporation which would result in an interest deduction to that particular individual.

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."

While we hope our comments are of assistance to you they do not address all of the potential income tax implications nor do they constitute an advance income tax ruling and therefore are not binding on the Canada Customs and Revenue Agency.

Yours truly,

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