20 September 2006 External T.I. 2006-0198861E5 - Interest Deduction - Linking/Tracing

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: Personal line of credit used for both investment and personal - is % of loan balance acceptable

Position: Yes - Flexible approach per paragraph 20 of IT-533

Reasons: Tracing/Linking Concept

									2006-019886
XXXXXXXXXX 								C. Tremblay, CMA
									613-957-2139
September 20, 2006

Dear XXXXXXXXXX:

Re: Interest Deductibility -Tracing/Linking Through Lines of Credit

This is in reply to your e-mail of July 21, 2006, wherein you asked our assistance to clarify the interest deduction that would be allowed on an investment/personal line of credit based on the example that follows:

A taxpayer has a personal line of credit for $60,000 as of January 1, 20XX. In the same month, the personal line of credit is increased by $40,000 to a new balance of $100,000. The additional $40,000 was invested in securities for an income earning purpose with a financial advisor. You conclude that for January the interest that can be deducted for income tax purposes is 40% of the interest paid or payable (depending on the method regularly followed by the taxpayer in computing the taxpayer's income) based on the $100,000 balance owing. The taxpayer then reduces the personal line of credit by paying down the balance by $20,000 as of February 1, 20XX. The new balance at February 1, 20XX is now $80,000 and the $40,000 remains invested with the financial advisor. Therefore, you conclude that the interest that can be deducted for income tax purposes for February would be 50% of the interest paid or payable (depending on the method regularly followed by the taxpayer in computing the taxpayer's income) based on the $80,000 balance owing. The taxpayer then further reduces the personal line of credit by paying down the balance by $40,000 as of March 1, 20XX. The new balance is now $40,000 and the same amount remains invested with the financial advisor. You conclude that for the balance of the year, the taxpayer is allowed to deduct 100% of the interest paid or payable (depending on the method regularly followed by the taxpayer in computing the taxpayer's income) on the line of credit.

Our Comments

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject of an advance income tax ruling request submitted in a manner set out in Information Circular 70-6R5. (This Information Circular and the Interpretation Bulletin referred to below can be accessed on the internet at http://www.cra-arc.gc.ca.) As stated in paragraph 22 of Information Circular 70-6R5, written opinions are not advance tax rulings and, accordingly, are not binding on the Agency. The following comments are, therefore, of a general nature only.

Paragraph 20(1)(c) of the Income Tax Act governs the deductibility of interest expense for income tax purposes and, for purposes of your example, generally, limits the deduction to interest on borrowed money which is used for the purpose of earning income from a business or from property. Interpretation Bulletin IT-533, entitled Interest Deductibility and Related Issues, discusses the Agency's interpretations of the deductibility of interest expense under various provisions of the Act and the judgments in numerous court decisions involving the deductibility of interest expense. (References to the court decisions in this letter are listed in Appendix A to IT-533.) The courts have determined that it is the direct use to which the borrowed money is applied which governs whether the interest is deductible for tax purposes.

Further, the Supreme Court of Canada has stated that the onus is on the taxpayer to trace funds to a current eligible use (Bronfman Trust). When borrowed money is directly applied to a given use, its use is readily determined. Recent decisions of the Supreme Court have introduced the concept of linking borrowed money, rather than tracing it, to its use, as well as approving of a flexible approach to tracing/linking (Tennant, Shell, Singleton). In this context, a practical approach can be used to determine the use of borrowed money and its redeployments.

Paragraph 20 of IT-533, indicates that taxpayers are entitled to apply the flexible approach to tracing/linking. Consequently, where borrowed money and other money are commingled, taxpayers may choose the uses of the borrowed money from all of the uses of the money. As a reasonable proxy for tracing, if taxpayers can demonstrate that the aggregate eligible expenditures from a commingled cash account exceed the amount of borrowed money deposited to that account, the Agency will generally accept that the taxpayer has satisfied the test of tracing borrowed money to eligible uses. The same approach would also be applicable to lines of credit and other similar arrangements.

Accordingly, we confirm that a flexible approach as suggested in your example can be used, provided the funds from the personal line of credit continue to be used for the purpose of earning income from a business or from property.

We trust our comments are of assistance.

Yours truly,

R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate