29 January 2001 External T.I. 2000-0063185 - 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 borrowed money used to purchase common shares.

Position TAKEN:

Interest cost would generally be deductible provided that the facts indicate that the potential return to the shareholder may exceed the shareholder's borrowing costs.

Reasons FOR POSITION TAKEN:

For interest to be deductible, there must be a source of income from a property.

XXXXXXXXXX 							2000-006318

January 29, 2001

Dear XXXXXXXXXX:

Re: Interest deductibility

This is in reply to your letter dated December 18, 2000 in which you requested our views as to whether your acquisition of an undivided interest in a parcel of land qualifies as an investment in a limited partnership and if the borrowing costs with respect to the acquisition are deductible. In addition, you requested our general comments concerning the deductibility of interest on borrowed money used for the purpose of investing in technology stocks.

Our comments

From an examination of a copy of the co-ownership agreement which you have provided, it would appear that the land acquisition would not be an investment in a limited partnership but a participation as a co-owner in a parcel of land. We would refer you to XXXXXXXXXX the co-ownership agreement entitled "No Partnership" which provides that "It is not the intention of the Co-Owners to be partners nor to create a partnership by this agreement".

Assuming the arrangement is not a partnership, as a co-owner of an undivided interest in land, consideration should be given to the application of subsection 18(2) of the Income Tax Act (the "Act"). In general terms, subsection 18(2) of the Act denies the deduction of interest on debt relating to the acquisition of land as well as property taxes incurred by the taxpayer (see XXXXXXXXXX the co-ownership agreement) in respect of the land unless the land is held primarily for the purpose of gaining or producing income from the land or is used in the course of a business carried on by the taxpayer in the year, other than the business of resale or development of such land. Whether vacant land is held for the purpose of gaining or producing income from the land or is used in the course of carrying on a business is a question of fact that can only be determined after a review of all of the relevant details of the particular situation.

Where subsection 18(2) of the Act applies to deny a deduction to a taxpayer in respect of an amount of interest and/or property taxes paid by the taxpayer in a taxation year, the taxpayer is entitled to add such amounts to the cost of the land under subsection 10(1.1) of the Act if the land represents inventory of a business. On the other hand, if the land is capital property of the taxpayer, paragraph 53(1)(h) of the Act provides for an addition to a taxpayer's adjusted cost base of land for the amount of interest on borrowed money and property taxes for which a deduction is denied under subsection 18(2). In this way, any gains on the subsequent disposition of the land by the taxpayer will be reduced.

Where in a particular taxation year, a taxpayer derives revenue from the land (i.e. other than proceeds of disposition of the land), the taxpayer would be entitled to deduct interest and property taxes to the extent required to offset the income derived from such revenue (i.e. the revenue less other deductible expenses). Subsection 18(2) of the Act would only deny a deduction in respect of any excess.

In relation to your request for a technical interpretation with respect to the deductibility of interest on borrowed money used for the purpose of investing in the common shares of a technology company, our comments will be general, considering that this is a hypothetical question. The question of whether such interest is deductible turns on whether the common shares were acquired for the purpose of earning income. This is a question of fact and the particular facts of each situation must be examined in order to make the determination. Interpretations given at various income tax conferences at which the Agency was responding to queries, we stated that interest on money borrowed to acquire common shares is generally (barring exceptional circumstances) deductible, bearing in mind that the potential return to the shareholder may exceed the shareholder's borrowing costs.

However, for any expense to be deductible, there must be a source of income. We are of the opinion that there is no source of income where the facts show that there is no profit or expectation of profit. Subsection 9(3) of the Act excludes capital gain from income. The increase in value of a property may therefore not be used to justify a deduction under paragraph 20(1)(c). As a result, despite our above-mentioned general position, we are of the opinion that the interest on money borrowed to purchase common shares might not be deductible where there is no expectation of profit from the investment. For instance, where a company has not paid any dividends since being formed and the facts clearly show that it has no intention of so doing, there could be a good argument for concluding that there is no expectation of profit and that the interest on money borrowed to purchase its common shares would not be deductible.

We hope that the above is of assistance to you.

for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch