5 March 2012 Internal T.I. 2010-0384681I7 - Preamble to subsection 20(1) of the Income Tax Act

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: In the preamble to subsection 20(1) of the Act, what does the word "source" refer to?

Position: The word "source" in the preamble to subsection 20(1) of the Act refers to the "taxpayer's income for a taxation year from a business or property" referred to earlier in the preamble and not to the expenses described in the paragraphs (a) - (ww) which follow.

MEMORANDUM-TO-FILE

March 5, 2012								2010-038468
									L. Carruthers, CA

Issue

In the preamble to subsection 20(1) of the Income Tax Act (the "Act"), (reproduced below), what does the word "source" refer to?

"Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:"

Position

The word "source" in the preamble to subsection 20(1) of the Act refers to the "taxpayer's income for a taxation year from a business or property" referred to earlier in the preamble and not to the expenses described in the paragraphs (a) - (ww) which follow.

This interpretation is supported by the French version of the preamble of subsection 20(1) of the Act, which expressly refers to amounts that are wholly applicable to "that source of income" ("...sommes suivantes qui se rapportent entièrement à cette source de revenus...").

Analysis

To the extent that a taxpayer has a source of income for a taxation year from a business or property, the preamble to subsection 20(1) of the Act allows expenses, otherwise denied from deduction in the computation of income from that source due to paragraphs 18(1)(a), (b) or (h) of the Act, to be deductible in computing the income from that source, if such expenses meet the requirements of any of the paragraphs 20(1)(a) - (ww) of the Act.

For example, with respect to the expenses described in subparagraph 20(1)(e)(i) of the Act, there are two tests which have to be met for deductibility:

• The test required by the subparagraph is that the expenses must be incurred in the course of an issuance or sale of the units of, the interests in, or the shares of the taxpayer. Paragraph 16 of IT-341R4, Expenses of Issuing or Selling Shares, Units in a Trust, Interests in a Partnership or Syndicate and Expenses of Borrowing Money, contains a list of those expenses which meet the requirements of subparagraph 20(1)(e)(i) of the Act.
• The test required by the preamble is that such expenses may only be deducted in computing a taxpayer's income for a taxation year from a business or property (a "source"), to the extent those expenses are wholly applicable to that source, or to the extent such part of those expenses may reasonably be regarded as applicable thereto.

The above position is different from the interpretation of the preamble of subsection 20(1) of the Act as set out in documents numbered 2008-0272441I7, 2003-0021817, 2002-015144, 2002-0151485, 2002-0150835, 9704727, 9615787, 9109706, and 9014576 and should be considered to override such earlier interpretations. However, it should be noted that, in our view, the above position does not change the tax consequences in any of those documents because, given the facts specific to each of those scenarios, the above position was implicit in the interpretations previously provided.

Impact

The phrase "wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto" in the preamble to subsection 20(1) of the Act, requires that expenses described in paragraphs 20(1)(a) - (ww) of the Act must be prorated between a taxpayer's sources of income and its activities, if any, which do not constitute a source of income.

A proration of this nature is, in our view, supported by the general rule that deductions must be sourced to related income. A simple and clear summary of this requirement to prorate, as it relates to the preamble to subsection 20(1) of the Act, can be found in Côté-Reco Inc. v. Minister of National Revenue [80 D.T.C. 1012]:

"27 First, the evidence established that the condition set forth in the preamble of subsection 20(1), which is a preliminary condition of all the succeeding paragraphs, namely paragraph 20(1)(a) to paragraph 20(1)(f), was met. This condition is that in computing the income from a business or property the sum indicated in the various paragraphs, which may be deducted, is that relating entirely to the source of income.

28 In the case at bar, the expense was claimed in computing the income in the appellant's financial year. The loan was made for the purpose of the business. The payment of premiums was in order to guarantee the loan.

29 It might have been difficult if the appellant, having two separate businesses, had tried to deduct the insurance premium in computing the income of A -- when the loan had been made for business B, which had made no income in that year."