18 March 2003 External T.I. 2003-0181635 - BORROWING GIA GIC UNIVERSAL LIFE

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

1) Borrowing to invest in GIC? and a GIA?

2) Borrowing to invest in Universal Life?

Position TAKEN:

1) Yes
2) No
REASON FOR POSITION: 20(1)(c)

XXXXXXXXXX  							2003-018163
C. Tremblay, CMA
March 18, 2003

Dear XXXXXXXXXX,

This is in reply to your electronic mail message of November 7, 2002, and further to a telephone conversation (XXXXXXXXXX/Tremblay) of February 28, 2003, wherein you asked specific questions on the deduction of interest under paragraph 20(1)(c) of the Income Tax Act (the "Act").

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.

If a taxpayer invests in a guaranteed investment certificate ("GIC") and borrows funds to invest, the interest on the borrowed money is deductible under paragraph 20(1)(c) of the Act provided the loan is made pursuant to a legal obligation to pay interest and the amount is reasonable. It is also essential that the investment have an income earning purpose, that is, the taxpayer should have a reasonable expectation of income at the time the investment is made.

Subparagraph 20(1)(c)(i) of the Act provides a deduction in computing a taxpayer's income from business or property in respect of interest on borrowed money used for the purpose of earning such income, but specifically excludes any deduction in respect of interest on money borrowed to acquire a life insurance policy. The term "life insurance policy" is defined in subsection 138(12) of the Act and includes an annuity contract and a contract where all or any part of the insurer's reserves for such contracts are based on the fair market value of a specified group of assets. Subsection 20(2.2) of the Act creates certain exceptions to the definition of life insurance policy for the purposes of paragraphs 20(1)(c) and (d) of the Act which effectively permit interest on money borrowed to acquire certain insurance products to qualify for a deduction under those paragraphs. Assuming that paragraph 20(2.2)(c) of the Act applies to a guaranteed investment annuity ("GIA"), a deduction in respect of interest paid or payable by a taxpayer to acquire an interest in such a product may be available, subject in part, to whether the other conditions described in paragraph 20(1)(c) and (d) of the Act are met (and subject to the limitation in subsection 18(11) of the Act).

As noted above, specifically excluded from eligibility for deduction is interest on borrowed money used to acquire an interest in a life insurance policy. As a universal life insurance contract is considered a life insurance policy, the interest paid or payable on borrowed funds to acquire such a product is not deductible for income tax purposes.

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