7 June 1995 Roundtable Q. 13, 9513880 - INTEREST DEDUCTIBILITY - BORROW TO REPAY CAPITAL

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:

Whether interest would be deductible where a corporation with no "adjusted equity", as defined in proposed section 20.2(2), borrows money to repay capital?

Position TAKEN:

1. Question of fact. Presently, interest would only be deductible on borrowings used to replace capital that was used for the purpose of earning income from a business or property, as long as the use test continues to be met.

2. If the legislation passes as proposed, the interest would not be deductible.

Reasons FOR POSITION TAKEN:

1. Consistent with our position in IT-80.

2. The draft legislation is clear that interest is only deductible to the extent of adjusted equity.

Revenue Canada Round Table
Canadian Petroleum Tax Society Conference
June 7, 1995

Question 13

INTEREST ON FUNDS BORROWED TO DISTRIBUTE

A corporation has no "adjusted equity" under proposed subsection 20.2(2). However, the corporation has $5 million of paid-up capital in respect of its issued shares.

If the corporation borrows $5 million to repay capital, will the interest be deductible?

What progress, if any, has been made in eventually enacting the proposed legislation and will it be amended to conform with IT-80?

Department's position

In order to deduct interest, pursuant to paragraph 20(1)(c) of Act, one of the requirements is that the borrowed money be used for the purpose of earning income from a business or property (the "purpose test"). The transitional rule found in draft section 20.2 makes it clear that borrowed money used to make a capital distribution will be treated as having been used for the purpose of earning income from a business or property, only to the extent of the distributor's adjusted equity immediately before the distribution. Therefore, if the corporation has no adjusted equity at the time of making the distribution, the borrowings to fund such a distribution would likely not meet the requirements of paragraph 20(1)(c), in light of Bronfman Trust and Livingston International decisions. Therefore, interest would not be deductible with respect to such borrowings.

This result is inconsistent with our administrative position, which would allow an interest deduction in respect of borrowings used to replace capital which had been used for the purpose of earning income from a business or property. This position applies to the extent that the borrowed funds continue to be used for this purpose and is consistent with paragraphs 3 & 4 of IT-80.

Finance is aware of the fact there are some inconsistencies between the proposed transitional rules and our administrative practices. In the Department of Finance Release #87-89, dated June 2, 1987, it states the proposed transitional legislation referred to above is intended to confirm Revenue Canada, Taxation's current administrative treatment with respect to deductibility of interest. At the 1992 Corporate Management Tax Conference, the Department of Finance also stated that "any discrepancy between Revenue Canada's practice and the draft law will be corrected by changing the law".

No final deadline for release of any revisions has been set.

Author: A. Nelson
File: 951388
Date: June 1, 1995