4 May 2004 External T.I. 2004-0062231E5 - Shareholder interest-free loan; deduct interest

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: whether interest is deductible in various fact situations where a shareholder borrows money (at interest) and loans money interest-free to a corporation in which the shareholder owns shares

Position: question of fact

Reasons: question of fact

            2004-006223
XXXXXXXXXX        Denise Dalphy, LL.B.
(613) 941-1722
May 4, 2004

Dear XXXXXXXXXX:

We are writing in reply to your e-mail of February 15, 2004 wherein you requested our views on interest deductibility where shareholders of a corporation borrow money at interest and loan that money interest-free to the corporation and the loans made by shareholders to the corporation are not made in proportion to their shareholdings in the corporation. In particular, you described hypothetical situations where Mr. X (who owns 75% of the shares of XY Co) loans $80,000 to XY Co and Mr. Y (who owns 25% of the shares of XY Co) loans $20,000 to XY Co, and where Mr. X (with 75% of the shares) loans $1 million to XY Co and Mr. Y does not loan money to XY Co.

You have also indicated that the paragraph 25 of Interpretation Bulletin IT-533 ("IT-533"), Interest Deductibility and Other Issues, which was issued on October 31, 2003 is not the same as the text in other cancelled Interpretation Bulletins ("ITs") in that the earlier ITs did not refer to interest-free loans made in proportion to a shareholder's interest in the company.

Our Comments

Written confirmation of the consequences inherent in particular transactions are given by this directorate only where the transactions are seriously proposed in the near future and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R5. Notwithstanding the foregoing, we are providing the following general comments.

As is indicated in IT-533, interest on borrowed money to make an interest-free loan is not generally deductible since there is a direct ineligible use, as no income will be generated from the loan. However, we have described certain exceptions where the Canada Revenue Agency would generally accept the deduction of interest on borrowed money used by a shareholder to make an interest-free loan to a corporation in which the shareholder has an interest.

It is a question of fact whether a shareholder can establish that exceptional circumstances exist such that a shareholder who borrows money in order to make an interest-free loan to a corporation that it holds shares in will result in an interest deduction for that particular shareholder. No general guidelines can be provided as to when such a borrowing will qualify until a significant body of caselaw has been established. However you may wish to review the reasons for the decisions in cases such as R. v Canadian Helicopters (2002 DTC 6805) or 74712 Alberta (formerly Cal-Gas Equipment Ltd.) v. The Queen (97 DTC 5126).

IT-533 was released on October 31, 2003 and it lists the ITs that were cancelled on the same date. Although the wording in paragraph 25 of IT-533 is not identical to that in previous ITs, they merely provide examples of some transactions that would generally not be challenged by the Canada Revenue Agency (the "CRA").

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