6 July 2010 External T.I. 2009-0331651E5 - Interest deductibility

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.

Principal Issues: Where interest on a line credit is deductible, will interest on an increased borrowing against that line of credit be deductible when the increased borrowing is used to pay interest on the line of credit?

Position: It depends on the facts.

Reasons: It is a question of fact whether the original interest on the line of credit would be paid resulting in the interest on the increased borrowing being deductible when paid or payable pursuant to paragraph 20(1)(c) of the Act or, rather, if the original interest on the line of credit would be compounded resulting in the interest on the increased borrowing being deductible only when paid pursuant to paragraph 20(1)(d) of the Act.

XXXXXXXXXX
									2009-033165
									L. Carruthers, CA
July 6, 2010

Dear XXXXXXXXXX :

Re: Interest Deductibility

This is in reply to your correspondence of July 9, 2009, wherein you asked for our assistance to clarify the interest deduction that would be allowed, pursuant to the Income Tax Act (the "Act"), in a particular scenario. You have described a scenario which includes a mortgage on a house as well as both a line of credit ("LOC") and a chequing account used exclusively for investment purposes. In the scenario, you indicated that the intent was to utilise the chequing account in a manner that allowed the manual compounding of the interest owing on the LOC.

Our Comments

Your request appears to be an actual fact situation relating to a proposed transaction. Written confirmation of the tax implications inherent in an actual proposed transaction is given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in a manner set out in Information Circular 70-6R5. As stated in paragraph 22 of IC 70-6R5, written opinions are not advance tax rulings and, accordingly, are not binding on the Canada Revenue Agency. The following comments are, therefore, of a general nature only.

Paragraph 20(1)(c) of the Act allows a taxpayer to deduct simple interest paid or payable in the year on borrowed money used by the taxpayer for the purpose of earning income from a business or property. Specifically, subparagraph 20(1)(c)(i) refers to "an amount paid in the year or payable in respect of the year (depending on the method regularly followed by the taxpayer in computing the taxpayer's income), pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy)". It is a question of fact whether borrowed money is used for the purpose of earning income from a business or property.

Compound interest (i.e., interest on interest) is only deductible pursuant to paragraph 20(1)(d) of the Act, and only in the year in which it is actually paid. Specifically, paragraph 20(1)(d) refers to "an amount paid in the year pursuant to a legal obligation to pay interest on an amount that would be deductible under paragraph 20(1)(c) if it were paid in the year or payable in respect of the year." It is a question of fact whether an amount of interest paid, or payable, in a year is simple or compound interest.

As indicated in the attached Income Tax Rulings Directorate documents 2007-0254941E5, 2005-0116661C6 and 2004-007034, in our view, interest paid or payable in the year on a second loan, that was used to pay interest on a first loan, is deductible in calculating income from a business or property of a taxpayer pursuant to paragraph 20(1)(c) of the Act, if the interest on the first loan is deductible, pursuant to that provision, in calculating the income of the taxpayer from that business or property. However, as indicated in the attached Income Tax Rulings Directorate document 9833077, in our view, the addition of accrued interest to the outstanding principal amount of an existing note and the execution of a new note, does not constitute payment of that interest and, therefore, a portion of the interest charged in respect of the new note would constitute compound interest and would only be deductible for tax purposes pursuant to paragraph 20(1)(d) of the Act in the year in which it is actually paid. It is a question of fact whether certain transactions result in the payment of interest with a second borrowed amount, or result in the addition of accrued interest to an outstanding principal amount with the execution of a new debt.

In the particular scenario you described, it would be a question of fact whether the original interest on the LOC would be paid, resulting in the interest on the increased borrowing being deductible when paid or payable pursuant to subparagraph 20(1)(c)(i) of the Act or, rather, if the original interest on the LOC would be compounded, resulting in the interest on the increased borrowing being deductible only when actually paid pursuant to paragraph 20(1)(d) of the Act.

As noted above, tax consequences surrounding the deductibility of interest depend on the facts of each situation. Where all the facts are known, and are the subject of an advance income tax ruling request submitted in a manner set out in Information Circular 70-6R5, we would be prepared to deal conclusively with this issue in the context of such an advance income tax ruling request.

We trust that our comments will be of assistance.

Yours truly,

R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate