27 January 1999 Internal T.I. 9830747 - INTEREST EXPENSE TO REDUCE 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: Deductibility of interest on funds borrowed to reduce paid-up capital

Position: OK, subject to certain restrictions

Reasons: Current departmental policy

			January 27, 1999

	TORONTO CENTRE TSO	HEADQUARTERS
J. P. Dunn
	Attention: James S. Mac Innis	(613) 957-2747
	                Conglomerates - 453.25
			983074

XXXXXXXXXX
Deductibility of Interest on Funds Borrowed to Reduce Capital

We are writing in response to your memorandum of November 19, 1998 in which you had enquired whether the views expressed in Interpretation Bulletin IT-80 regarding the deductibility of interest on funds borrowed to redeem shares is equally applicable to interest on borrowed funds to reduce the paid-up capital of shares.

At the 1996 Corporate Tax Management Conference, the Department was asked which “rules” it applies when dealing with the deductibility of interest to pay dividends, to make partnership distributions or to return partnership or corporate capital. The reply furnished by the Department was as follows:

The Department continues to apply its administrative position as was presented in former Interpretation Bulletin IT-80. Briefly, the position with respect to the deductibility of interest on funds borrowed to redeem shares or make distributions of partnership capital is that, in order to be fully deductible, the borrowed funds cannot exceed the aggregate of the paid-up capital of the shares or capital of the partnership, as the particular case may be, to be redeemed plus the accumulated profits of the corporation or the partnership determined immediately before the distribution. Further, accumulated profits and paid-up capital or capital, as the case may be, are relevant only to the extent that they have been used to earn income and have not been used to acquire property the income from which is exempt or to acquire a life insurance policy. In the case of funds borrowed to pay dividends or make distributions of profits to partners, only the accumulated profits are relevant to the determination.

In other words, the position of the Department regarding such transactions is that the interest is deductible to the extent that the borrowings are not in excess of the total paid-up capital of the shares in question if those shares are redeemed or, in circumstances such as you describe, the borrowings are not in excess of the paid-up capital reduction, in both cases subject to the proviso noted in the above reply that the paid-up capital has been used by the corporation income.

This position is consistent with the decision in Trans-Prairie Pipelines Ltd. v. MNR 70 DTC 6351 (Exch. Ct.).

We would further note that, subsequent to replying to the above question, the Department clarified that the reference to “paid-up capital” therein was meant to refer to the accounting concept of “capital” except in circumstances in which the capital has been increased in non-arm’s length transactions such as may occur in an amalgamation of related corporations. In such cases in which there is an increase to the capital because of a non-arm’s length transaction (other than a direct subscription for shares or capital contribution), the concept of capital for the purposes of measuring a the maximum borrowing permissable should be limited to the corporate capital as would be determined in the absence of such an increase.

We trust that this is the information which you require.

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate