20 July 2009 External T.I. 2009-0317041E5 - Spousal attribution re joint line of credit

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. Does the fact that a joint line of credit is secured by a property which the taxpayer contributed most of the capital for, in and of itself, result in attribution to the taxpayer pursuant to 74.1(1)?

2. Does the spouse's use of the funds drawn from the joint line of credit constitute an indirect transfer under subsections 56(4.1) or 56(2)?

3. Does the fact that the line of credit is registered jointly in the taxpayer's and the spouse's name, in and of itself, result in 74.5(7) applying?

4. With respect to the deductibility of interest under subsection 20(1), how would the interest be allocated between the spouses?

Position: 1. No. 2. Generally no. 3. Generally yes. 4. General comments given.

Reasons: 1. Supplying collateral for a loan does not constitute a transfer or a loan. 2. Where the taxpayer has made no loan to the spouse, 56(4.1) would not apply. Where the taxpayer has not directed the issuers to do something and the investment income would not otherwise be the taxpayer's because the spouse is the legal holder of the investments, 56(2) would not apply. 3. Where the taxpayer is obligated, either absolutely or contingently, to ensure the repayment, in whole or in part, of the joint line of credit or of any part of any interest payable on the joint line of credit, 74.5(7) would apply. 4. It is a question of fact.

XXXXXXXXXX 							2009-031704
L. Carruthers, CA
July 20, 2009

Dear XXXXXXXXXX :

Re: Spousal attribution using a joint line of credit

This is in reply to your correspondence of April 7, 2009, wherein you asked our assistance to clarify the tax consequences to a taxpayer and spouse when they have a joint line of credit and the spouse draws funds from the line of credit and uses these funds to generate income from property.

Your correspondence contained the following scenario:

• A married couple acquired a family home for which the taxpayer contributed most of the capital to acquire the home.
• A line of credit, secured by the family home, is obtained and is registered jointly in the taxpayer's and the spouse's names (the "joint LOC").
• Each of the taxpayer and the spouse have equal and unrestricted access to funds available from the joint LOC. Withdrawals from the joint LOC by the taxpayer or the spouse do not require the authority of the other.
• The spouse draws funds from the joint LOC and invests the borrowed funds in a portfolio of income producing investments.

Specifically, you requested clarification of the following:

• Given the taxpayer contributed most of the capital to acquire the family home, and the joint LOC obtained was based on the equity in that property, is there any attribution to the taxpayer pursuant to subsection 74.1(1) of the Income Tax Act (the "Act")?
• Does the use of the funds drawn from the joint LOC constitute an indirect transfer under subsections 56(4.1) or 56(2) of the Act?
• Does the use of the joint LOC by the spouse, for the purpose of earning property income, constitute a guarantee under subsection 74.5(7) of the Act?
• With respect to the deductibility of interest under subsection 20(1) of the Act, how would the interest be allocated between the spouses?

Our Comments

The facts in your letter appear to relate to a factual situation involving specific taxpayers. As stated in paragraph 22 of Information Circular 70-6R5, "Advance Income Tax Rulings" dated May 17, 2002, when a request relates to a specific proposed transaction, an advance income tax ruling must be requested rather than a technical interpretation. Furthermore, should your situation involve a completed transaction, you should submit all relevant facts and documentation to the appropriate tax services office for their views. Nevertheless, we offer the following comments in connection with your request.

It should be noted that it is a question of fact as to whether attribution applies to any particular situation and the issue can only be decided on a case-by-case review of all the pertinent information. Furthermore, interest on borrowed funds is deductible pursuant to paragraph 20(1)(c) of the Act only to the extent that those borrowed funds can be considered to have been used for the purpose of earning income from a business or from property. The resolution of this question from the perspective of the taxpayer or the spouse would require an analysis of all of the pertinent facts surrounding the acquisition of the portfolio of income producing investments. Also, the possible application of anti-avoidance provisions in subsection 74.5(11) or section 245 of the Act would depend on these facts. Accordingly, we are unable to provide a definitive response to your specific questions by way of a technical interpretation. The following comments are of a general nature only.

Subsection 74.1(1) of the Act applies where a taxpayer loans or transfers property to or for the benefit of another person who is, or has become, the taxpayer's spouse or common-law partner. In that case, any income or loss derived from property, or from property substituted therefor, that relates to a period throughout which the taxpayer is resident in Canada, is attributed to the taxpayer. Subsection 74.2(1) contains similar rules with respect to any taxable capital gains or allowable capital losses arising from the disposition of such property or property substituted for it.

In a situation where one spouse does not contribute any funds to the purchase of a property but ownership is jointly registered to both spouses, there has been a transfer of property from one spouse to the other at the time of purchase. However, in the current scenario, the provision of collateral for a loan does not constitute a loan or transfer of property, and therefore, the fact that the joint LOC is secured by the family home which the taxpayer contributed most of the capital for, in and of itself, does not result in the attribution rules of subsection 74.1(1) or 74.2(1) of the Act applying.

With respect to the use of the joint LOC, it is a question of fact whether the taxpayer, the spouse, or the taxpayer and the spouse, borrow money from and/or make repayments to the joint LOC.

Borrowed by Taxpayer

Any portion of the joint LOC borrowed by the taxpayer and used to buy a portfolio of income producing investments in the name of the spouse would constitute a transfer from the taxpayer to the spouse, and the attribution rules of subsections 74.1(1) and 74.2(1) of the Act would apply with respect to any income, loss, capital gain and allowable capital loss derived from the property. Furthermore, such a use of the borrowed money, in our view, would not be an eligible use pursuant to paragraph 20(1)(c) of the Act because the money was not borrowed by the taxpayer for the purpose of earning income. Accordingly, in such a situation, the taxpayer would not be entitled to a deduction for the interest paid or payable on the joint LOC.

Borrowed by the Spouse

Any portion of the joint LOC borrowed by the spouse, and used to buy a portfolio of income producing investments in the name of the spouse, in our view, would be an eligible use pursuant to paragraph 20(1)(c) of the Act because the money was borrowed for the purpose of earning income. However, for any such money borrowed by the spouse, whether the spouse or the taxpayer repaid the joint LOC, or any interest payable on the joint LOC, would be relevant in determining whether the attribution rules of the Act applied.

Pursuant to subsection 74.1(3) of the Act, if the taxpayer pays any portion of the principal or interest, subsection 74.1(1) of the Act would apply to attribute all future income or loss from the income producing investments to the taxpayer. Subsection 74.1(3) does not result in subsection 74.2(1) of the Act applying.

Whether or not the taxpayer pays any portion of the principal or interest, if the taxpayer is obligated, either absolutely or contingently, to ensure the repayment, in whole or in part, of the joint LOC, or of any part of the interest payable on the joint LOC, pursuant to subsection 74.5(7) of the Act, the taxpayer is deemed to have made the loan to the spouse and, subject to the exemption for commercial loans, the attribution rules of subsections 74.1(1) and 74.2(1) of the Act would apply.

The exemption for commercial loans is found in subsection 74.5(2) of the Act and, in the current scenario, would require that interest, at a rate not less than the prescribed, or a commercial, rate of interest in effect at the time the joint LOC was incurred, be charged by the LOC provider and be paid to the LOC provider not later than 30 days after the end of each calendar year in which the joint LOC is outstanding. Paragraph 74.5(7)(b) of the Act provides that, for the purpose of determining whether the requirements of subsection 74.5(2) are met, only interest paid by the spouse to the LOC provider is considered (i.e., no interest paid by the taxpayer is considered).

Section 56

Subsection 56(4.1) of the Act is intended to prevent taxpayers from avoiding tax through loans to non-arm's length individuals. Under this subsection, income from property that is diverted by a taxpayer to a non-arm's length individual through a low interest or an interest-free loan where income-splitting is one of the main reasons for the loan, will be taxed in the taxpayer's hands.

Pursuant to subsection 56(4.3) of the Act, the attribution rules in subsection 56(4.1) apply to loaned property or indebtedness which is used either to repay borrowed money that was used to acquire property or to reduce an amount payable for that property.

In our view, subsection 56(4.1) of the Act would not apply to the scenario you presented because that subsection requires a loan from the taxpayer to the spouse, of which there is no evidence in the scenario you presented. However, pursuant to subsection 56(4.3) of the Act, if the taxpayer loans property to the spouse, and the property is used to repay the joint LOC, subsection 56(4.1) could apply. Furthermore, if a guarantee on the joint LOC is honoured by the taxpayer, and the purpose test in the subsection is met, subsection 56(4.1) could apply.

Subsection 56(2) of the Act provides that where a taxpayer directs or concurs in the payment of an amount to another person, that amount shall be included in the taxpayer's income where, if it had been paid to him, it would have been so included.

In our view, subsection 56(2) of the Act would not apply because the taxpayer has not directed a payment that would otherwise be the taxpayer's. The taxpayer has not directed the issuers to do anything and the investment income would not otherwise be the taxpayer's because the spouse is the legal holder of the investments.

Anti-avoidance

We would also like to mention that, in our view, the anti-avoidance rules of subsection 74.5(11) or section 245 of the Act may have application where it can be shown that the primary purpose, or one of the main purposes, of the transactions was to reduce the tax liability of the taxpayer or the spouse. This, of course, could not be determined until there was a thorough review of the facts in an actual situation.

We trust that these comments will be of assistance to you.

Yours truly,

R.A. Albert, CA
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch