14 January 2005 Internal T.I. 2004-0098141I7 - Interest deductibility ; assumed debt

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: 1. Is interest deductible where corporate taxpayer assumes shareholders mortgage in return for forgiveness of debt owing by corporate taxpayer to its shareholoder 2. Is interest deductible if the debt of the corporate taxpayer that was forgiven was incurred by it to acquire common shares from the shareholder

Position: 1. No. 2. No.

Reasons: 1. Not borrowed money and no property is acquired. 2. No evidence of any connection between the assumption by the corporate taxpayer of the mortgage and the acquisition by it of the common shares.

						January 14, 2005

WINNIPEG TSO						HEADQUARTERS
Business Audit						Denise Dalphy, LL.B.
						Financial Industries Division
Attention :  Michael Luzny						(613) 941-1722

							2004-009814

Interest Deductibility

This is in reply to your memorandum dated October 12, 2004 wherein you asked for our comments on the deductibility of interest payments by a corporate taxpayer. The particular situation is that the corporate taxpayer assumed liability to pay the principal and interest owing on a mortgage on the shareholder's personal residence, and, in consideration, part of an earlier non-interest bearing loan owing by the corporate taxpayer to the shareholder (which resulted from the transfer - in a prior year - of public shares from the shareholder to the corporate taxpayer) was forgiven by the shareholder.

Our Comments

Subparagraph 20(1)(c)(i)

It has been the Canada Revenue Agency's longstanding interpretation (pursuant to the Supreme Court decision in M.N.R. v. T.E. McCool [1949] CTC 395 (SCC), wherein the Court interpreted the term "borrowed money" and distinguished lender-borrower relationships from debtor-creditor relationships) that the assumption of indebtedness is not "borrowed money" for the purposes of subparagraph 20(1)(c)(i) of the Income Tax Act (the "Act").

Subparagraph 20(1)(c)(ii)

Subparagraph 20(1)(c)(ii) of the Act provides for an income tax deduction for "an amount paid in the year or payable in respect of the year...pursuant to a legal obligation to pay interest on" "an amount payable for property acquired for the purpose of gaining or producing income from the property or the purpose of gaining or producing income from a business ..." [emphasis added].

In the present situation, the corporate taxpayer assumed an interest-bearing liability (its shareholder's mortgage) and, in return, another non-interest bearing liability of the corporate taxpayer was forgiven. While a right to collect a debt is a property, the liability to pay a debt is not a property. Accordingly, in this case, since the corporate taxpayer did not acquire any property in the second transaction, subparagraph 20(1)(c)(ii) of the Act will not apply.

While the corporate taxpayer did acquire shares of public corporations in an earlier transaction and as consideration issued corporate indebtedness to its shareholder, we are not aware of any evidence that there was any connection between the subsequent assumption by the corporate taxpayer of its shareholder's mortgage and the acquisition of any property, including the public shares.

We hope this opinion will be of assistance.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

Steve Tevlin
Manager
Corporate Financing Section
Financial Industries Division
Income Tax Rulings Directorate