17 July 1996 Internal T.I. 9618550 - 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.

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 pay dividends, redeem shares or make distributions of partnership capital.

Position:

Dividends or patnership distributions - Borrowed funds cannot exceed accumulated profits of the corporation/partnership.

Share redemptions - Borrowed funds cannot exceed total of accumulated profits plus PUC of shares to be redeemed.

Reasons:

Basically, a restatement of the positions in this respect in former IT - 80 prior to cancellation.

1996 CORPORATE MANAGEMENT TAX CONFERENCE

QUESTION NUMBER 1

Interpretation Bulletin IT-80 was cancelled shortly after the decision of the Supreme Court in The Queen v. Bronfman Trust, 87 DTC 5059. On December 20, 1991, the Department of Finance released draft legislation concerning the income tax treatment of interest on borrowed funds. The legislation dealt with, inter alia, the deductibility of interest on money borrowed by a corporation to make distributions by way of dividend, redemption or acquisition of shares or reduction of capital, and interest on money borrowed by a partnership to make a distribution of profits or capital. Proposed section 20.2 would govern the treatment of borrowed money used to make distributions at any time before the date on which the legislation is issued in final form and proposed section 20.1 would apply to borrowings after that time.

What rules is Revenue Canada currently applying: the rules as stated in Interpretation Bulletin IT-80, or the rules in draft section 20.2 ?

RESPONSE

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.

It is our understanding that the provisions of proposed section 20.2 were intended to codify the Department's administrative position. Also, representatives of the Department of Finance have publicly stated that, to the extent that the new provisions prove to be more restrictive than the existing administrative position, the new provisions will be modified to eliminate those discrepancies.