Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation]
Can a taxpayer deduct interest on a loan where the money borrowed is used to acquire investments that generate a 1% annual return from a corporation the taxpayer controls?
Position:
Question of fact.
Reasons:
Application of paragraph 20(1)(c) and paragraph 31 of IT-533.
XXXXXXXXXX 2004-009294
L. J. Roy, CGA
November 30, 2004
Dear Sir,
Subject: Interest deductibility
This is in response to your request of August 25, 2004 for an opinion on the deduction of interest.
First, you wish to know whether interest will be deductible in a situation where a taxpayer borrows money from a bank at an interest rate of 6% and uses the borrowed money to acquire preferred shares or debentures, which generate a dividend or interest of 1%, of a corporation controlled by the taxpayer. Furthermore, you wish to know the impact of the application of section 3.1 as proposed by the draft amendment to the Income Tax Act, introduced on October 31, 2003, in another situation.
Interest on borrowed money is deductible under paragraph 20(1)(c) of the Income Tax Act if the money is used for the purpose of earning income from a business or property. As stated in paragraph 31 of IT-533, where an investment (e.g., interest-bearing instrument or preferred shares) carries a stated interest or dividend rate, the purpose of earning income test will be met "absent a sham or window dressing or similar vitiating circumstances". In our view, the fact that the corporation is controlled by the taxpayer, or that the dividend is cumulative or non-cumulative, or that the debenture is or is not convertible into common shares of the issuer, is not sufficient in itself to conclude that the purpose of earning income test has not been satisfied. In addition, paragraph 31 of IT-533 states that interest will neither be denied in full nor restricted to the amount of income from the investment where the income does not exceed the interest expense.
With respect to the legislative proposals of October 31, 2003 referred to above, the Minister of Finance stated in his budget of March 23, 2004:
In its release, the Department emphasized that the sole intent of the proposals is to restore the law and related administrative practices to what they were generally understood to be in the past. Some commentators have nonetheless expressed concern that the proposals could have more far-reaching effects. While this is not the intention behind these proposals, a number of significant issues have been raised that deserve further consideration.
It is important to ensure that there is an adequate opportunity for taxpayers to comment on the proposals, and for the Department to consider those comments. Accordingly, the Department intends to extend the period for making written submissions on these proposals until the end of August of this year.
As these proposals are still under review by the Department of Finance, we cannot comment on their impact on interest deductibility until the Department of Finance makes public the outcome of its review.
Best regards,
Manager
Financing and Plans Section
Financing and Plans Division
Income Tax Rulings Directorate
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