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: What amount of interest is deductible where a personal mortgage is increased, the additional borrowed money is used for investment purposes and then payments are made against the mortgage?
Position: A constant prorated portion based on initial eligible vs. ineligible use.
Reasons: Tracing/Linking concept relevant where cash and borrowed funds are co-mingled not where single borrowed account is utilized for eligible and ineligible purposes.
XXXXXXXXXX 2006-021838
L. Carruthers, CA
September 7, 2007
Dear XXXXXXXXXX:
Re: Interest Deductibility -Tracing/Linking
This is in reply to your letter of December 12, 2006, wherein you asked our assistance to clarify the interest deduction that would be allowed on a mortgage account utilized for investment as well as personal purposes based on the hypothetical situation as follows.
A taxpayer has an outstanding mortgage balance of $60,000 as of February 1, 2007. On February 1, 2007, the mortgage is increased by $40,000 to a new balance of $100,000. The additional $40,000 is invested in securities, with a financial advisor, for an income earning purpose. The taxpayer then reduces the mortgage by paying down the balance by $20,000 on June 1, 2007. The new balance at June 1, 2007, is now $80,000 and $40,000 remains invested with the financial advisor. You conclude that the interest that can be deducted for income tax purposes for February through May 2007, would be 40% of the interest paid or payable (depending on the method regularly followed by the taxpayer in computing the taxpayer's income) based on the $100,000 balance owing.
On September 1, 2007, the taxpayer further reduces the mortgage by paying down the balance by $40,000. The new balance is now $40,000 and the same amount remains invested with the financial advisor. You conclude that the interest that can be deducted for income tax purposes for June through September 2007, would be 50% of the interest paid or payable (depending on the method regularly followed by the taxpayer in computing the taxpayer's income) based on the $80,000 balance owing.
Furthermore, you conclude that for the balance of the year, the taxpayer would be allowed to deduct 100% of the interest paid or payable (depending on the method regularly followed by the taxpayer in computing the taxpayer's income) based on the $40,000 balance owing on the mortgage.
Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject of an advance income tax ruling request submitted in a manner set out in Information Circular IC-70-6R5. (This Information Circular and the Interpretation Bulletins referred to below can be accessed on the internet at http://www.cra-arc.gc.ca.) As stated in paragraph 22 of
IC-70-6R5, technical interpretations are not advance tax rulings and, accordingly, are not binding on the Agency. The following comments are, therefore, of a general nature only.
As noted in your letter, in an earlier interpretation covering a similar hypothetical situation (our reference # 2006-019886) we referred to the flexible approach to tracing/linking as discussed in paragraph 20 of Interpretation Bulletin IT-533, entitled "Interest Deductibility and Related Issues", and stated that the approach suggested in the interpretation (analogous to your conclusions noted above) could be used, provided that the funds from the relevant portion of the personal line of credit (analogous to $40,000 of the mortgage as noted above) continued to be used for the purpose of earning income from a business or from property.
We have revisited the approach suggested in 2006-019886 and have concluded that it is not in line with the courts or Canada Revenue Agency's views on the flexible approach to tracing/linking. The approach suggested in 2006-019886 (analogous to your conclusions noted above) would allow taxpayers to allocate repayments to specific advances from a line of credit (mortgage or loan) and this was not the finding in Colin C. Mills v. MNR 85 DTC 632 ("Mills"), nor is it the intent of the comments in paragraph 20 of IT-533.
In Mills, at one time the taxpayer kept his investment and personal loan accounts separate. Through inadvertence, the accounts were merged. Following the merging of accounts, the Tax Court concluded that capital repayments could not be traced to the personal loan account vs. the investment loan account. The result of this was that, of the balance still to be paid, part was for investment and part was for personal use items. A portion of the interest claimed by the taxpayer was found to be not deductible.
Furthermore, the comments in paragraph 20 of IT-533 relate to tracing borrowed money, which is co-mingled in an account with cash, to eligible uses, and not to tracing or allocating repayments of money borrowed for various uses under a single line of credit (mortgage or loan) to specific ineligible or eligible uses. In our view, any repayment of the principal portion of a line of credit (mortgage or loan) would reduce both the portions of the line of credit (mortgage or loan) used for eligible purposes and used for ineligible purposes.
Accordingly, in your hypothetical situation (as well as that of 2006-019886), the taxpayer cannot specifically allocate payments on the mortgage (loan or personal line of credit) to money that was borrowed for personal or ineligible uses. Once the mortgage (loan or personal line of credit) is brought up to $100,000, its use it 60% ineligible and 40% eligible. Any payment on the mortgage (loan or personal line of credit) will be considered made in that same ratio and any interest paid or payable (depending on the method regularly followed by the taxpayer in computing the taxpayer's income) will be deductible in that ratio. Therefore, when payments are made and the balance is reduced to $80,000, and then $40,000, the interest remains deductible on the basis of 60% ineligible and 40% eligible.
In your hypothetical situation, and as described in paragraph 15 of IT-533, it would be acceptable for the taxpayer to dispose of the investment and pay off the $40,000 September 1, 2007, balance on the mortgage, and then reacquire the investment with a $40,000 line of credit (or other borrowing), for which the interest would be 100% deductible. Such a disposition would need to be reported for tax purposes. However, it should be noted that if a loss arises on the disposition and within 30 days the same investment is reacquired, rules regarding the claiming of superficial losses would apply. Generally, these rules operate to defer the recognition of losses for income tax purpose. Paragraph 11 of IT-456R, entitled "Capital Property - Some Adjustments to Cost Base", provides further comments on these rule.
We trust our comments are of assistance.
Yours truly,
R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
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