31 March 1989 Income Tax Severed Letter 7-3643 - []

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.

DATE March 31, 1989

To International Audits Division J.A. Calderwood, Director

Attention: J. Waszut Audit Programs Directorate

FROM Financial Industries Division
 Blair P. Dwyer 
                    (613)957-2744

SUBJECT: Paragraph 20(1)(d) of the Income Tax Act (Canada) (the "Act")

This is in reply to your memorandum dated February 6, 1989, in which you asked for our opinion on paragraph 20(1)(d) of the Act.

You are concerned that interest on simple interest is deductible under paragraph 20(1)(d) but that interest on compound interest is not.

Technically, the above statement is a correct expression of the law. As an administrative matter, however, the Department generally grants a deduction for interest on compound interest provided that the underlying compound interest is deductible.

We will illustrate this by referring to the example presented in Appendix I of your memorandum. In the example, a bank lends $1,000,000 for five years at 10% interest per annum, compounded annually. To simplify the illustration, we will assume that no payments are made until maturity on the fifth anniversary of the obligation. The amounts of yearly interest are as follows:

                                          A                       B                       C                           D

                                                 Interest                                  Interest
                             Compounded          on Non-             Interest on          on Compound 
                              Principal        compounded           Simple Interest        Interest in 
                               Amount           Principal               in (B)             (C) & (D)
                          ------------------------------------------------------------------------------------------------------
Year One                       1,000,000       100,000

Year Two                       1,100,000       100,000                  10,000

Year Three                     1,210,000       100,000                  20,000                1,000

Year Four                      1,331,000       100,000                  30,000                3,100

Year Five                      1,464,100       100,000                  40,000                6,410 

Maturity                       1,610,510

The amounts in column (B) represent simple interest on the principal advanced and will be eligible for deduction under paragraph 20(1)(c) of the Act on a paid or payable basis. The amount in column (C) represents interest on the simple interest in column (B) and will be eligible for deduction under paragraph 20(1)(d) only when paid. The amount in column (D) represents interest on the compound interest shown in columns (C) and (D). Administratively, this amount is eligible for deduction under paragraph 20(1)(d) on a paid basis provided that the compound interest in (C) is eligible for deduction under paragraph 20(1)(d).

The administrative position referred to in Mr. Robertson's memo to file, dated September 11, 1979, applies only in the case of financial institutions. All other taxpayers may deduct compound interest only when the compound interest is paid. We should point out that on your copy of this memorandum, the word "not" has been erroneously crossed out in line 2 of criterion (ii). To satisfy criterion (ii), the interest must be accruing on interest that is payable but that has not yet become due. If the interest is accruing on overdue interest, the normal rules in paragraph 20(1)(d) apply. Mr. Robertson's memo to file was the basis for a memorandum dated November 1, 1979 to all District Offices, a copy of which is enclosed.

We trust that the above comments will be of some assistance. If you have any further questions, please do not hesitate to contact us.

Director Financial Industries Division Rulings Directorate