19 June 1996 External T.I. 9619525 - DEDUCTIBILITY OF INTEREST EXPENSE

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:

Deductibility of Intereest

Position:

Gave general position based on law

Reasons:

XXXXXXXXXX 5-961952

June 19, 1996

Dear Sir:

Re: Deductibility of Interest Expense

This is in reply to your letter of May 28, 1996 in which you request a ruling with respect to the deductibility of interest on an investment in limited partnerships which XXXXXXXXXX.

The situation described in your letter is an actual fact situation and written confirmation of the tax implications inherent in proposed transactions are given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R2 (copy enclosed). Where a completed transaction is involved, the enquiry should be addressed to your local District Tax Services Office. Consequently, we can only offer the following general comments.

Interest on borrowed money is deductible pursuant to paragraph 20(1)(c) of the Income Tax Act (the "Act") (subject to restrictions in some situations) where the borrowed money is used for the purpose of earning income from a business or property. Section 20.1 of the Act applies where, because of a loss of source of income, borrowed money ceases to be used for an income-earning purpose. These rules ensure that interest on such borrowed money will, in certain circumstances, continue to be deductible under paragraph 20(1)(c) of the Act provided all the conditions of this paragraph are met.

Generally, borrowed money will cease to be used for the purpose of earning income from a property when the taxpayer sells or otherwise disposes of the property. However, in some circumstances, borrowed money may cease to be so used while the taxpayer still owns the property - for example, where a taxpayer has used borrowed money to acquire shares of a corporation that has subsequently become bankrupt.

Subsection 20.1(5) of the Act applies where a taxpayer has used borrowed money to acquire an interest in a partnership. It specifies that the borrowed money may be considered to be used for the purpose of earning income from the partnership interest and subsection 20.1(1) the Act will apply much the same way as it applies to borrowed money used to acquire shares in a corporation.

The determination as to whether interest is deductible under paragraph 20(1)(c) of the Act is based, in part, on tracing the use of the borrowed money. If the decrease in the adjusted cost base of a partnership interest is attributable to drawdowns by the partners of capital from the partnership, the borrowed money is traceable to an ineligible use and the amount of the decrease is not considered to be lost because of a decline in value of property for purposes of section 20.1 of the Act. If the decrease in the adjusted cost base of the partnership interest is a result of losses of the partnership, the amount of borrowed money used to acquire the consideration, for purposes of subsection 20.1(1) of the Act, will be based on the fair market value of the property received in satisfaction of the partnership interest and the original cost of the partnership interest.

Generally, the amount of borrowed money to which subsection 20.1(1) of the Act applies is the total amount of borrowed money outstanding just before it ceases to be used to earn income from the property minus the amount of borrowed money that is not considered to have been lost determined as follows:

-money that is traceable to an ineligible use such as a drawdown of capital

-where the property has been disposed of for an amount of consideration at least equal to the fair market value of the property, the amount of the borrowed money that, under the existing rules, is traceable to the consideration, and

-otherwise, the amount of the borrowed money that would, under existing rules, be traceable to the money received by the taxpayer if the taxpayer had disposed of the property for an amount of money equal to the fair market value of the property.

We trust that our comments will be of assistance to you but caution that they are not binding on the Department.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch