30 April 1997 External T.I. 9707525 - INTEREST EXPENSE IN A PARTNERSHIP

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 interest expense in a proprietorship where equity account is in a deficit position

Position:

Question of tracing borrowing to an eligible use

Reasons:

Expenses must be incurred to earn income

		970752
XXXXXXXXXX	C. Tremblay

Attention: XXXXXXXXXX

April 30, 1997

Dear Sirs:

Re: Deductibility of Interest Expense in a proprietorship

This is in reply to your letter of March 18, 1997, requesting whether it is our policy to restrict the deductibility of interest expense in a business when the proprietor's equity account is in a deficit position.

The situation that is described appears to involve a series of actual completed transactions involving specific taxpayers; consequently, your questions should be directed to your District Taxation Services Office which has the responsibility of determining the tax consequences of completed transactions and their implications to specific taxpayers. Although we are unable to comment on the specific transactions outlined in your letter, we have set out below our general comments on the interest deductibility issue you have raised.

In general, expenses incurred in respect of a business or property are deductible only if they are incurred for the purpose of earning income. Each case is judged on its own particular merits and it is a question of fact whether the circumstances of a particular case involving the borrowing of money would support a conclusion that there was a reasonable expectation of income from a business. Where such cannot be demonstrated, the interest would not be deductible as the purpose test in paragraph 20(1)(c) would not be satisfied.

Since paragraph 20(1)(c) of the Act establishes the requirement to trace the use of the borrowed funds, it is the Department's position with respect to the deductibility of interest that it is the current use of the funds which must satisfy the eligible purpose test. Accordingly, it is not the purpose of the borrowing but rather the purpose of the use of the funds which is relevant when determining whether the criteria of paragraph 20(1)(c) is met. Where borrowed funds are used to pay personal expenses, interest on those funds is not a deductible expense under paragraph 20(1)(c) of the Act.

We trust these comments will be of assistance.

Yours truly,

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