17 December 1991 Administrative Letter 9124586 F - Partnerships

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.

19(1) (the "Taxpayer")

This is in reply to your memorandum of September 4, 1991 in which you asked us to comment on previous Rulings opinions issued to the Belleville District Office regarding the Taxpayer and his investments in  24(1)

We also acknowledge the additional information provided by 24(1) the taxpayer's representative in a letter to Kingston District Office Appeals dated July 19, 1991 and in a letter to Belleville District Office  —  Audit dated November 28, 1990.  The relevant facts have been summarized in our previous memoranda dated August 15, 1988, October 14, 1988, December 28, 1989 and March 8, 1990 and therefore will not be repeated here.  We have reviewed your analysis and offer the following comments.  All references to statute are to the Income Tax Act.

Opinion24(1)  Two decisions must be made with respect to the determination of the Taxpayer's income for tax purposes:  is the Taxpayer's share of partnership losses deductible under paragraph 3(d) and is the interest expense on loans taken to purchase the partnership interests deductible under subparagraph 20(1)(c)(i). 

Different tests are used to determine whether these amounts are deductible.  The deductibility of interest on funds borrowed by a partner is determined independently of whether the business carried on by the partnership is carried on for profit.  Accordingly it is entirely possible, given the scheme of the Act, to have a situation where interest on funds borrowed by a taxpayer to acquire an interest in a partnership will not be deductible notwithstanding that the business carried on by the partnership is carried on at that level, which is independent of external financing, with a view to profit.

Partnership losses are deductible if it can be determined that there is a reasonable expectation of profit from the business operation.  This test is performed annually at the partnership level and independent of the cost of borrowings made at the partner level.  On the other hand interest expense is deductible if the payment of interest is made for the purposes of producing income from property or business.

This test is performed annually on a partner by partner basis.  There can be instances where a business venture being undertaken by a partnership will have a reasonable expectation of profit and therefore the startup losses will be deductible but for certain time periods generally and for certain partners specifically interest expense will not have been incurred for the purposes of producing income and therefore will not be deductible by the partner.  If the borrowings take place at the partnership level, we might conclude that there was no reasonable expectation of profit after looking at the overall loss and would deny the deduction of the partnership losses including the interest expense.  An investment may make economic sense but the interest expense would not be considered to have been expended for the purpose of producing income from property or business in the year in question and therefore not deductible in circumstances where the amount of the interest is expected to be in excess of the partner's share of partnership income. 

The Department's general position on the deductibility of interest with respect to moneys borrowed to purchase common shares should not be viewed as an open licence for the deductibility of interest in all circumstances.  The deductibility of interest with respect to any particular share purchase or any other investment must be judged on the specific facts to determine whether there is a potential return in excess of the borrowing costs.

A number of factors must be reviewed in the Taxpayer's situation to determine whether interest is deductible:

24(1)

24(1)

In our previous memoranda we did not address the assessment policy to be used in future years when a loan is still outstanding and 24(1), for example, shows a profit.  The facts surrounding the case must be examined in the context of the expectations of the investors at each future date (i.e. the test for interest deductibility is an annual one).  The decision to deny the deductibility of interest costs in year 1 does not mean that an investor will forever be unable to deduct interest with respect to his investments in 24(1).  Should circumstances change such that it can reasonably be expected that the investor's share of future partnership income will exceed the current year and future years' interest costs, an investor would be able to deduct his interest costs at that time.

In our March 8, 1990 memorandum we did not intend to give the impression that interest expense is only deductible if income is earned during the period that the loan is outstanding.  Our comment was predicated on our view in this particular case that when the loan matures in year the partner will exercise his "put" and repay the loan.  As a consequence no income will be earned during the period which the loan is outstanding and during the period the property acquired with the proceeds of the loan was held. As a result it would seem to be difficult to substantiate the claim that the money was borrowed for the purpose of earning income and accordingly we expressed the view that the interest expense would not be deductible.

21(1)(b),24(1)

We hope that these additional comments are of assistance to you.

Brian DarlingDirectorFinancial Industries DivisionRulings Directorate

c.c.  Belleville District Office Chief of Audit