10 November 1988 Income Tax Severed Letter 7-3112 - [Mortgage Arrangement Fee]

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.

Nov 10 1988

Head Office Specialty Rulings Directorate C.R. Bowen (613) 957-2094

SUBJECT: Mortgage Arrangement Fee

We are writing in reply to your memorandum of July 26, 1988, wherein you requested our comments on the income tax treatment of the mortgage arrangement fee paid by XXXX (the "Partnership").

Our understanding of the facts is as follows:

XXXX

Your Questions

You have requested our comments on whether the First Mortgage Fee paid by the Partnership is

1) an interest expense deductible under paragraph 20(1)(c) of the Act, or

2) an expense of borrowing money deductible under paragraph 20(1)(e) of the Act.

Our Comments

A) Background

It is our opinion that the First Mortgage Fee to be charged to the Partnership was for three services that the XXXX had agreed to provide:

1) XXXX

2) XXXX

3) XXXX

As the XXXX were able to obtain the First Mortgage at an interest rate of XXXX without the necessity of buying it down, no part of the First Mortgage Fee represents an amount paid by the Partnership to buy down the interest rate. Therefore, it is our opinion that the services received by the Partnership were for items 2) and 3) above.

Although Legislation Branch Letter #79-12 dated September 24, 1979 and the Addendum dated December 22, 1981 (the "LBL") deal specifically with "Multiple Unit Residential Buildings as Tax Shelters", the positions outlined are equally applicable to the XXXX sold as a tax shelter. Therefore, me have referenced the LBL in our comments below.

B) An Expense of Borrowing Money

It is our opinion that the First Mortgage Fee should be treated as an expense incurred in the course of borrowing money used by the taxpayer for the purpose of earning income from a business or property. XXXXXXXX. Paragraph 21(k) of the LBL dealing with mortgage brokerage fees (or finder's fees) indicates that:

... a mortgage placement fee will be deductible in the year incurred and in which money is borrowed. Such a fee will be considered incurred when the mortgage broker bills for same and consequently the investor becomes liable to pay same to the broker.

Paragraph 19(h) of Interpretation Bulletin IT-341 also discusses the type of expenses incurred in the course of borrowing money which are deductible under paragraph 201)(e) of the Act as follows:

Certain 'soft costs' incurred by an investor in the course of financing the construction of a building for the purpose of earning income therefrom on property of which he has the beneficial ownership at the time such costs are incurred. The more frequently encountered 'soft costs' (i.e. costs not related to the acquisition of the land, buildings and equipment) paid by an investor which are deductible under paragraph 20(1)(e) are:

- mortgage brokerage (placement) and finder's fees, if paid after November 16, 1978, and ...

The other part of the XXXX of having to accept financing of the First Mortgage with an interest rate in excess of XXXX. This protection or insurance is an amount incurred by the Partnership in the course of borrowing money.

Therefore, to the extent that the First Mortgage Fee is reasonable, it may be deducted as an expense by the Partnership in 1985 pursuant to subparagraph 20(1)(e)(ii) of the Act. Whether or not the amount of the fee charged is reasonable in the circumstances (and hence deductible) can only be determined by a review of all of the relevant facts of the situation. In this regard, the fee should bear a reasonable relationship to the cost of obtaining similar services from an independent outside party. The reasonableness of the fee should be determined by your office due to your familiarity with all the facts.

C) Mortgage Buy Down

Had there been an actual buy-down of the interest rate of the First Mortgage, the income tax treatment would be as indicated in paragraph 21(j) of the LBL which states as follows:

In order to sell the investment the promoter may be required to obtain financing at a rate lower than that at which the loan could be obtained on the open market. A fee to the investor for such "buy down" of interest rates is considered a payment on account of interest, deductible over the period of the "buy down", pursuant to the provisions of paragraph 20(1)(c) of the Act.

This amortization of the prepaid interest expense is also in accordance with paragraph 20(D)(ii) of the LBL which indicates that prepaid expenses of a partnership are deductible on the basis of the guidelines described in Interpretation Bulletin IT-417 . The income tax treatment of an interest rate buy down payment is also discussed in the Policy and Systems Branch Letter # 88-9 dated August 8, 1988. Here, the Department confirmed that it will continue to consider these payments as prepayments of interest expense deductible under paragraph 20(1)(c) of the Act, prorated over the life of the debt.

We trust these comments will be of assistance to you.

Original Signed by

T. Harris

Chief Merchandising, Manufacturing and Construction Section Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch