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: Are financing costs under paragraph 20(1)(e) of the Act deductible where the indirect use of funds test under paragraph 20(1)(c) of the Act is met as commented on in paragraphs 22 to 26 of IT-533?
Position: YES
Reasons: Par 9 IT 341R3, Trans-Prairie Pipelines Ltd. 70DTC 6351
2005-016166
XXXXXXXXXX C. Tremblay, CMA
(613) 957-2139
March 14, 2007
Dear XXXXXXXXXX:
Re: Paragraph 20(1)(e) of the Income Tax Act (the "Act") and the "Indirect Use" Principle
This is in reply to your correspondence of December 2, 2005, regarding the above-noted subject and the exceptions to the direct use test of paragraph 20(1)(c) of the Act.
In your correspondence, you convey your concern and disagreement with the comments in our letter dated October 19, 2005 (document No. 2005-01512117) where we stated that the comments dealing with the indirect use test as commented on in paragraphs 22 to 26 of Interpretation Bulletin IT-533, entitled Interest Deduction and Related Issues would not apply to paragraph 20(1)(e) of the Act.
Specifically, from page 4 of the above-noted document:
"IT-533 - Indirect Use of Funds
The Courts have applied an indirect use test to paragraph 20(1)(c) of the Act on limited occasions, in particular, in Trans-Prairie Pipelines Ltd. v MNR, 70 DTC 6351 and Penn Ventilator Canada Ltd. v The Queen, 2002 DTC 1498 (TCC). There is no jurisprudence that has extended the application of this principle to paragraph 20(1)(e) of the Act [or to paragraphs 20(1)(d) or (e.1) or (f) of the Act]. Accordingly, the comments in paragraphs 22 to 26 of IT-533 would not apply to paragraph 20(1)(e) of the Act."
The tax cases noted were resolved under the provisions of paragraph 20(1)(c) of the Act, however, we agree with your comments that former 11(1)(cb) now paragraph 20(1)(e) of the Act was also considered in Trans-Prairie Pipelines Ltd.
We have confirmed in document No. 2002-0138413 and in document No. 9728513 that the portion of the financing fees incurred for the return of capital will be deductible in the manner described in paragraph 20(1)(e) of the Act. Further, paragraph 9 of Interpretation Bulletin, IT-341R4, titled Expenses of Issuing or Selling Shares, Units in a Trust, Interest in a Partnership or Syndicate and Expenses of Borrowing Money, dated February 26, 2007, states: "if a taxpayer incurs expenses when borrowing money, paragraph 20(1)(e) and (e.1) require that the taxpayer use the borrowed money for the purpose of earning income from a business carried on by the taxpayer or for the purpose of earning non-exempt income from property. For example, this requirement is met when bonds are issued and the proceeds are used to redeem preferred shares..." This last sentence has been in all the revised versions of IT-341 and is supported by the Trans-Prairie Pipelines Ltd. decision. The original version of IT-341 is dated August 30, 1976.
Accordingly, it is our view that provided the interest expense on the borrowing meets the exceptions to the direct use test under paragraph 20(1)(c) of the Act as commented on in paragraphs 22 to 26 of IT-533, the financing costs associated with the borrowing would also be deductible in the manner described in subparagraph 20(1)(e)(ii) of the Act.
The comments above represent our general views with respect to the subject matter, and as indicated in paragraph 22 of Information circular 70-6R5, do not constitute an advance 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 our comments are of assistance.
Yours truly,
R. Albert, CA
For Director,
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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