8 June 1989 Ministerial Letter 32378 F - Deductibility of Interest on Mortgage

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.

Subject: 19(1)

This letter is to inform you of a ruling request which we received (copy attached) related to taxpayers in your district.  We have informed the taxpayer's lawyer that a ruling would have been negative.  However, as we do not know if the taxpayers intend to carry out the proposed transactions, we are notifying you.

19(1)

In our opinion, the interest on the new mortgage would not be deductible.  In general, we would allow the interest to be deductible where the requirements of paragraph 20(1)(c) of the Income Tax Act (the Act) were met and if the transactions were bona fide.   However, where the sale is merely a formality or sham which conceals the essence of the transaction we would seek to disallow the interest if it is ascertained that the borrowed funds are in fact used for an ineligible purpose.  For example, in Dunn vs. M.N.R. 74 DTC 1121, a taxpayer sold securities and used the proceeds to buy a life insurance policy.  He then borrowed on the policy to repurchase the securities and deducted the interest on that loan from the income earned by the repurchased securities. The Tax Review Board agreed with our position that the borrowed money was in fact used for an ineligible purpose (i.e. to purchase the life insurance policy) and the disallowance of the interest expense was upheld.  This case was cited in The Queen v. P.B. Bronfman Trust, 87 DTC 5059 (SCC) by Dickson, C.J. in obiter dictum.  He supported the decision of the Tax Review Board in Dunn (supra) and indicated that the essence of a transaction is a formality or sham.  At the Canadian Tax Foundation's 1987 Corporate Management Tax Conference (see questions 30 and 31, pp 10:24 - 10:25), the Department confirmed this position.

In the present situation, the taxpayers propose to transfer an asset to a partnership for the sole purpose of creating a situation where interest on a loan originally borrowed to purchase their principal residence will be deductible as a business expense.  In our opinion, even if the taxpayers were able to satisfy the technical requirements of paragraph 20(1)(c) of the Act, subsections 245(2) and (3) of the Act would probably apply to deny the tax benefit intended.  The saving provision in subsection 254(4) would likely not apply as the above mentioned court cases indicate the transactions would result in a misuse or abuse of the provisions of the Act.

We trust this information will be of assistance to you.

B.W. DathDirectorSmall Business and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch