3 November 1994 External T.I. 9424475 - INTEREST DEDUCTIBILITY

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Would interest continue to be deductible after a subsection 86(1) reorganization, where the fair market value of the original shares has declined and the consideration taken back on the reorganization reflects this declined value? Look at the issue before and after January 1, 1994.

Position TAKEN:

Generally speaking, interest should be deductible on the full amount of the loan, both before and after January 1, 1994.

Reasons FOR POSITION TAKEN:

Before 1994: Subsection 86(1) deems the cost of the new shares to equal the cost of the old shares, and at Q.18 of the 1984 RT we stated that interest would remain deductible, to the extent the borrowing is reflected in the cost of the new income source.

After Jan.1/94: Subsection 20.1(1) and 20(1)(c) should apply.

		942447
XXXXXXXXXX	Allan Nelson

Attention: XXXXXXXXXX

November 3, 1994

Dear Sirs:

Re: Interpretation Request - Paragraph 20(1)(c)

This is in reply to your letter dated September 22, 1994, concerning the application of paragraph 20(1)(c) of the Act. You describe a hypothetical subsection 86(1) share for share exchange, where the original shares have declined in value and the shares received as consideration for the original shares have a fair market value which is less than the remaining amount of the loan initially taken out to acquire the original shares. No non-share consideration is received as part of this arrangement.

Without having all the facts in your particular situation, we are unable to comment on the continuing deductibility of interest expense incurred on the loan after the exchange of shares has occurred. However, we can provide you with the following general comments which we hope will be of assistance to you.

After 1993

For time periods after 1993, subsection 20.1(1) is intended to ensure that interest on borrowed money continues to be deductible, in certain circumstances, after there has been a loss of source of income.

Depending on the facts in a particular subsection 86(1) share for share exchange situation, interest on the outstanding amount of the loan used to buy the original shares should, generally speaking, continue to be deductible after the exchange.

Before 1994

For time periods before 1994, if (i) at the time of the exchange, the value of the replacement shares equals the reduced value of the original shares, (ii) subsection 86(1) of the Act applies to the exchange of the shares, and (iii) no other consideration is taken back on the exchange, then interest on the outstanding amount of the loan used to buy the original shares should, generally speaking, continue to be deductible.

In accordance with paragraph 21 of Information Circular 70-6R2, the above comments are only expressions of opinion on the application of the Income Tax Act to the hypothetical example given, and as such should not be construed as advance income tax rulings, nor are they binding on the Department.

We trust our comments will be of assistance to you.

Yours truly,

Chief
Financial Industries Division
Rulings Directorate
Policy and Legislation Branch