15 February 2005 External T.I. 2004-0094791E5 - Excluded 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 an interest in a limited partnership would be an excluded interest for the purpose of 40(3.1) in the following scenarios:

1) the partnership rents out all the property that it had previously been using in carrying on a business and begins to earn property income
2) the partnership refinances mortgage loans

Position: 1) No 2) Question of Fact

Reasons: 1) The partnership did not satisfy either condition of subsection 40(3.15).

2) Question of Fact.

XXXXXXXXXX 2004-009479
Shaun Harkin, CMA
February 15, 2005

Dear XXXXXXXXXX:

Re: Technical Interpretation Request: Excluded Interest - Subsection 40(3.15)

We are writing in reply to your facsimile of September 15, 2004, wherein you ask whether an interest in a limited partnership would be an excluded interest within the meaning of subsection 40(3.15) of the Income Tax Act (the "Act") in the following circumstances:

1) If the partnership had actively carried on a business from a date prior to February 22, 1994, but subsequent to that date leases all of its assets used in carrying on that business to a third party, and thereafter earns income from the property which it had owned on February 22, 1994.

2) If the partnership, in the course of refinancing mortgages, which had been incurred prior to February 22, 1994, incurs new mortgage financing when it commences to earn property income. The new principal balance on the mortgage exceeds the outstanding principal balance of the previous mortgage by 21.7%. The excess is solely attributable to the refinancing of accrued but unpaid interest on the original mortgage (17%) and mortgage refinancing costs (4.7%) and not for expansion purposes. The existing mortgage did not provide for the capitalization of accrued but unpaid interest to principal.

Our Comments

A partnership interest will qualify as an excluded interest if either condition of subsection 40(3.15) is met. Namely,

? the partnership actively carries on a business that was carried on throughout the period beginning on February 22, 1994 and ending at that time, or
? the partnership earns income from a property that was owned by it throughout that period,

unless, in that period there was a substantial contribution of capital or a substantial increase in the indebtedness of the partnership.

1) In our view, the intent of subsection 40(3.15) is that the two conditions of that subsection should be considered mutually exclusive. Since, in your situation, the partnership did not "actively carry on a business that was carried on by it throughout the period beginning February 22, 1994" nor did the partnership "earn income from a property that was owned by it throughout that period" the partnership interest will not qualify as an excluded interest.

2) Paragraph 40(3.16)(d) of the Act provides, for the purposes of subsection 40(3.15), that an amount will be considered not to be substantial where the amount is used for an activity that was carried on by the partnership on February 22, 1994 but not for a significant expansion of the activity nor for the acquisition or production of a film production. In your situation, if the refinancing is not for expansion purposes or for the acquisition or production of a film production and is for the purpose of carrying on an activity that was carried on by the partnership on February 22, 1994, the increase in the indebtedness of the partnership would not be considered substantial. The determination of whether or not an increase in the indebtedness of a partnership is used for a significant expansion or change in the activity carried on by that partnership is a question of fact that can only be determined following a review of all of the relevant facts pertaining to the particular situation.

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 Canada Revenue Agency. Our practice is to make this disclaimer in all instances in which we provide an opinion.

We trust the above comments are of assistance.

Yours truly,

Wayne Antle, CGA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate

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