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:
A taxpayer borrowed money to acquire shares of two corporations. Subsequently, the shares of one corporation are disposed of to a Holdco in accordance with the rollover provision in section 85. The individual received as consideration for the disposition an amount of cash, which is used for personal purposes, and shares of Holdco. The question is whether or not the interest on the outstanding loan balance is deductible.
Position:
The portion of the outstanding loan balance attributed to the acquisition of the shares disposed of will remain deductible if the value of the Holdco shares received as consideration for the shares disposed of exceeds the amount of the portion of outstanding loan balance.
Reasons:
Application of the flexible approach to linking in determining the current use.
XXXXXXXXXX 2007-021979
L. J. Roy, CGA
March 6, 2007
Dear XXXXXXXXXX
Re: Interest deductibility
This is in reply to your email of January 18, 2007 wherein you requested our comments on whether the interest on the outstanding loan balance would remain deductible in the following example.
In 2004, an individual used $200,000 of a personal loan of $ 300,000 to acquire shares of an existing professional corporation (P Co.). The remaining $100,000 was used to acquire shares of a hygiene corporation (H Co.). The outstanding loan balance is now $160,000. The individual will dispose of his shares in H Co. to his Holdco for their fair market value. The disposition will be done in accordance with the rollover provision in section 85 of the Income Tax Act ("Act"). The individual will receive as consideration for the disposition an amount of $100,000 cash (being the adjusted cost base of H Co. shares) and shares of Holdco. The cash portion of the proceeds will be used for personal purposes.
Unless otherwise stated, all statutory references are to the Act.
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 matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R5 entitled Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the enquiry should be addressed to the relevant tax service office. The following comments are, therefore, of a general nature only and are not binding on the Canada Revenue Agency ("CRA").
Subparagraph 20(1)(c)(i) permits the deduction of an amount paid in the year or payable in respect of the year, pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property.
In general, the test to be applied for the use of borrowed money is the direct use of the borrowed money and it must be done giving effect to the legal relationship. Furthermore, the relevant use is the current use and not the original use of the borrowed money. In determining the current use of the borrowed money, taxpayers must establish a link between the money that was borrowed and its current use.
The taxpayer must establish the current use in respect of the portion of the outstanding loan balance initially used to purchase the H Co shares with the consideration for the disposition of such share. So, it is the current use of 33 1/3 of the remaining balance that must be determined i.e. $53,333. In the situation described above, it is our view that any repayment of the principal portion of the loan reduces both the portion of the loan used to acquire the P Co shares and the portion of the loan used to acquire the H Co shares.
As stated in paragraph 18 of Interpretation bulletin IT-533, where property acquired with borrowed money is replaced with more than one property, a flexible approach to linking is permitted. Under the flexible approach to linking, taxpayers are entitled to allocate, on a dollar for dollar basis, the outstanding borrowed money to the value of the replacement properties acquired.
Therefore, provided that there is a reasonable expectation of income on the Holdco shares, it is our view that the portion of one third of the loan balance of $160,000 ($ 53,333) will remain deductible to the extend that the value of the Holdco shares received as consideration for H Co shares equals or exceeds the amount of $53,333.
These comments are provided in accordance with the guidelines set out in paragraph 22 of Information Circular IC 70-6R5 dated May 17, 2002, issued by the Canada Revenue Agency (the CRA) and are not considered binding on the CRA.
Yours truly,
Ghislain Martineau
Manager
Financial Sector and Exempt Entities Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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