12 June 2012 June STEP Roundtable, 2012-0449811C6 - Application of 20(1)(c) if 75(2) applies

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: Where subsection 75(2) applies to a situation, will 20(1)(c) apply to allow the person from whom the trust received the property claim a deduction for interest paid or payable?

Position: Generally yes, provided certain conditions are met

Reasons: no change to previous position - but a cautionary note included based on recent interest deductibility cases

STEP CRA Roundtable – June 2012

QUESTION 13

If an individual (the “Borrower”) uses borrowed money to purchase an income producing property and later settles this property (the “Initial Property”) on an inter vivos trust – where subsection 75(2) applies to attribute income earned on the property back to the transferor, would the CRA agree that the income attributed to the Borrower pursuant to subsection 75(2) would be considered ‘income from property’ for purposes of paragraph 20(1)(c) of the Act such that any interest on the borrowed money would continue to be tax deductible?

CRA Response

In general, income earned on property held in a trust will be attributed to the person from whom the property was received by the trust where subsection 75(2) applies. It is a question of fact as to whether property is held by a trust under either of the conditions described in paragraphs 75(2)(a) or (b). Where subsection 75(2) of the Act is determined to apply in respect of a particular property, it will deem any income or loss from the property, or any taxable capital gain or allowable capital loss from the disposition of the property to be that of the person from whom the trust received the property.

Subparagraph 20(1)(c)(i) of the Act generally 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. It is CRA’s general view that, provided that the Borrower continues to have a legal obligation to pay interest on the borrowed money, and that the trust continues to hold the Initial Property for the purpose of gaining or producing income which, pursuant to subsection 75(2), will be attributed to the Borrower, a deduction pursuant to paragraph 20(1)(c) may be claimed equal to the lesser of the interest paid in the year or payable in respect of the year (depending on the method regularly followed by the Borrower) or a reasonable amount thereof.

If the trust disposes of the Initial Property and acquires substituted property to which subsection 75(2) continues to apply, one issue that must be considered is the tracing/linking of the borrowed money to its current use. We refer you to the guidance provided in paragraph 18 of Interpretation Bulletin IT-533 – Interest Deductibility and Related Issues.

In general, the tax consequences surrounding the deductibility of interest depend on the unique facts of each situation. It should be noted that where a series of transactions is entered into merely to derive the benefit of an interest deduction, the general anti-avoidance rule may be relevant.

Kim Duval
2012-044981