20 November 2009 Internal T.I. 2009-0340251I7 - Paragraph 20(1)(e) deduction

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. Whether expenses qualify for deduction pursuant to paragraph 20(1)(e) of the Income Tax Act (the "Act"), where an old plan was substituted by a new one.

2. Should the substitution have occurred in the same year to be eligible for deduction?

Position: 1. Generally, a question of fact.

2. Not necessary.

Reasons: 1. Paragraph 20(1)(e) applies to permit the deduction of a financing expense where, inter alia, it is incurred in the course of a borrowing of money. Paragraph 12 of IT-341R3 provides comments on substitution.

2. Paragraph 14 of IT-341R4

								November 20, 2009

	Large File Case Division			HEADQUARTERS
	Compliance Programs Branch			Income Tax Rulings
	Calgary TSO	   					Directorate
	Attention: Ron Suttie				V. Srikanth

								2009-034025

		Paragraph 20(1)(e) Deduction

We are writing in response to your e-mail dated September 11, 2009, requesting our views on the deductibility of expenses pursuant to paragraph 20(1)(e) of the Income Tax Act (the "Act").

The facts of the case can be generally summarized as follows:

* A taxpayer has incurred legal expenses to put in place a shelf prospectus in Year 1.

* However, no money was borrowed in Year 1 under this shelf prospectus.

* In Year 2, a new shelf prospectus for the same amount of potential borrowings was put in place.

* Borrowings were received under the new prospectus in Year 3.

Your concern is:

For the legal expenses incurred in Year 1 to be deductible pursuant to paragraph 20(1)(e) of the Act, should the borrowings under the new prospectus in Year 3, have occurred in the same year as that of the old prospectus, i.e., in Year 1?

Our Comments

Subparagraph 20(1)(e)(ii) of the Act provides that such part of an amount (other than an excluded amount) that is not otherwise deductible in computing the income of the taxpayer and that is an expense incurred in the year or a preceding taxation year in the course of a borrowing of money used by the taxpayer for the purpose of earning income from a business or property (other than money used by the taxpayer for the purpose of acquiring property the income from which would be exempt), would be deductible over a five-year period. Further, subparagraph 20(1)(e)(ii.1) allows for the deduction of expenses incurred in the course of becoming indebted by reason of an amount having become payable by the taxpayer for property acquired to earn income and, subparagraph 20(1)(e)(ii.2) allows for the deduction of expenses incurred in the course of a rescheduling or restructuring of a debt obligation or an assumption of a debt obligation.

It should be noted that paragraph 12 of the Interpretation Bulletin IT-341R3 - Expenses of Issuing or Selling Shares, Units in a Trust, Interests in a Partnership or Syndicate, and Expenses of Borrowing Money, reflects that the provisions of paragraph 20(1)(e) regarding borrowing, will not apply where the money is never, in fact, borrowed. However, an exception to this rule applies in circumstances where a plan for a transaction involving a borrowing of money to be used for the purpose of earning income from a business is abandoned, but the transaction is actually carried out pursuant to a new transaction plan that was substituted for the original one.

This exception is based on BACM Industries Ltd v MNR, 73 DTC 90, [1973] CTC 2093, wherein a proposed issue of convertible debentures was cancelled due to market conditions, and instead a public equity issue was undertaken. Judge Lucien Cardin upheld that none of the changes made could be considered as separate or abortive attempts to borrow money or to issue shares. The different steps constituted an overall financing scheme and the total amount was an expense incurred in the course of issuing shares.

The Assistant Chairman of the Tax Review Board, in the BACM Industries, made the following comments when dealing with deductibility of expense under paragraph 20(1)(e) of the Act:

"I do not believe that any or the progressive changes which were made because of existing circumstances to the original plan for the financing of the company's expansion, and which changes were in the company's interest, can be considered as separate or abortive attempts to borrow money or to issue shares. The shares were successfully issued and the company's expansion was realized by means of a financing program which went through normal planning and experimental stages which nevertheless form part of one overall successful transaction."

Thus, in our view, expenses relating to an abandoned plan to borrow money, incur debt or restructure debt or reschedule debt, as discussed above, will be deductible under paragraph 20(1)(e) of the Act provided that the plan is eventually carried out pursuant to a new transaction plan that is substituted for the original one. However, it is a question of fact if a new transaction plan is in fact substituted for an original one. In the given situation, if the facts indicate that the Year 2 and Year 3 transactions are substituted for the Year 1 transaction plan, in our view, the deduction of the Year 1 expenses will not be denied because the borrowings did not take place in the same year that these expenses were incurred.

Regardless, expenses that do not meet the requirements of paragraph 20(1)(e), may qualify as "eligible capital expenditures", provided they meet the requirements of that definition in subsection 14(5) of the Act. Accordingly, in the given instance, if the new transaction beginning in Year 2 and completed in Year 3, is not considered to be a substitution of the aborted transaction in Year 1, the expenses related to the Year 1 transaction plan may qualify for deduction as provided under subsection 14(5) of the Act, beginning in Year 1.

Further, you wanted our views concerning the timing of such deduction, i.e., whether the deduction will be allowed in Year 1, Year 2 or Year 3. Paragraph 14 of IT- 341R4, states that:

"An expense, arising in the course of one of the transactions referred to in paragraph 2, will begin to be deductible, under the five-year apportionment rule, in the year in which the expense is incurred ... This would normally be the same year in which the transaction takes place. In certain cases, however, such an expense may begin to be deductible under paragraph 20(1)(e) ... in a year before the one in which the transaction took place. For example, this would be the case when an expense to arrange for an issuance of shares is incurred in a year prior to the one in which the shares are actually issued. In that situation, the expense will normally be considered to be incurred in the course of the issuance."

Thus, in the given situation, if the Year 2 and the Year 3 transactions are considered to be substituted for the original one, the expenses incurred in Year 1 will be considered to be incurred in the course of the issuance. In our view, the taxpayer can, therefore, claim deductions pursuant to paragraph 20(1)(e) in Year 1, though the new shelf prospectus is put in place in Year 2 and the actual borrowing in response to the new shelf prospectus, is completed in Year 3.

R.A. Albert, CA
For Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch