25 June 1999 External T.I. 9910015 - INTEREST EXPENSE. BUSINESS COMMENCEMENT?

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 mortgage interest on land to be used in a nursery business is income tax deductible.

Position: Interest on amounts payable for property acquired for the purpose of gaining or producing income from a business is generally income tax deductible. However, the business must have commenced.

Reasons: It is the Department's position (see IT-364) that expenditures incurred prior to the commencement of a business are not tax deductible.

XXXXXXXXXX 	J. Gibbons
		5-991001
June 25, 1999

Dear XXXXXXXXXX:

We are replying to your letter of March 25, 1999, in which you requested our views on whether your mortgage interest qualifies as a business expense.

As indicated in paragraph 22 of Information Circular 70-6R3 dated December 30, 1996, a request for a written opinion on a completed transaction is usually considered by the taxpayer’s local tax services office. However, while we are unable to provide a definitive opinion in respect of your specific situation, we have provided general comments. Also, we have forwarded a copy of this letter to the XXXXXXXXXX Tax Services Office so that they will be aware of our views. We suggest that you consult with them if you need further assistance.

You describe your situation as follows:

1. In XXXXXXXXXX, you bought a farm-type property with XXXXXXXXXX acres of land and a small house.

2. You state the you have paid off the house portion of the property with your own funds and took a mortgage of $XXXXXXXXXX on the land portion of the property.

3. You further state that you are planning to use the land portion of the property in a nursery business.

Generally, interest on an amount payable for property acquired for the purpose of gaining or producing income from a business is tax deductible pursuant to paragraph 20(1)(c) of the Income Tax Act. However, since you state that you are only planning to use the land in a nursery business, it appears that you have not yet commenced business operations. Accordingly, we refer you to Interpretation Bulletin IT-364,

“Commencement of Business Operations,” a copy of which is enclosed, which discusses the issue of whether expenditures incurred prior to the commencement of a business are tax deductible. Paragraph 6 of this bulletin states that expenses in respect of a proposed business that are incurred prior to the commencement of the business do not constitute a business loss or a non-capital loss and thus cannot be applied against income in the year the expenses were incurred, and cannot be carried back to be applied against income of the preceding year or forward to be applied against income of any subsequent year. Consequently, it is necessary to establish whether particular expenditures were incurred preceding the commencement of the business or whether the expenses were incurred during preliminary steps leading to the start of normal operations.

Since it is a question of fact whether a business was in fact commenced, it is not possible to be specific about the point in time when a contemplated business becomes an actual business. However, as stated in paragraph 2 of IT-364, it is the Department’s general view that a business commences whenever some significant activity is undertaken that is a regular part of the income-earning process in that type of business or is an essential preliminary to normal operations. A business would be viewed as being merely contemplated for the future if no serious or reasonably continuous efforts are being made to begin normal business operations.

Where property is used partly for business purposes and partly for some other reason, only the portion that can reasonably be related to the business may be deducted as a business expense. For example, in a situation such as yours (if and when interest is determined to be tax deductible), the portion of the interest expense that relates to the principal residence would have to be deducted from the total interest payable to arrive at the deductible business portion. Thus, if you paid $XXXXXXXXXX for the property, and the fair market value of the principal residence (land and building) equals $XXXXXXXXXX, it is our view that two-ninths (i.e., XXXXXXXXXX) of the interest payable would not be deductible in computing income from your business. In determining the portion of land that relates to the principal residence, reference may be made to the method described in paragraph 27 of Interpretation Bulletin IT-120R4, “Principal Residence,” a copy of which is attached.

We trust that these comments will be of assistance.

Yours truly,

J.F. Oulton, CA
for Director
Business and Publications Division
Income Tax Rulings and Interpretations Directorate