Paragraph 20(1)(c)

Cases

TDL Group Co. v. Canada, 2016 FCA 67

interest on money borrowed to acquire (non-dividend producing) common shares of a subsidiary was deductible

The ultimate parent of the taxpayer's group ("Wendy's International") lent Cdn.$234 million to a US subsidiary ("Delcan") at 7% interest, which then lent the money at 7.125% interest to the taxpayer ("TDL"). TDL used those funds to subscribe for common shares of its wholly owned U.S. subsidiary ("Tim's U.S."), and Tim's U.S., in turn, lent the money interest-free back to Wendy's International. It was intended that this be replaced by an interest-bearing note but, due to delays, the interest-free loan to Wendy's International was not repaid by it (following that loan’s assignment by Tim's U.S. to a new U.S. subsidiary) until seven months later. The TaxCourt had denied an interest deduction to TDL on its borrowing during the seven-month period, finding that TDL did not have "any reasonable expectation of earning non-exempt income of any kind" on its common share investment in Tim’s U.S.

After asking (at para. 18) the question, “how is it that there was no income earning purpose during the first seven months…but an income earning purpose thereafter?” Dawson JA stated (at para. 19) that “this paradox stems from two legal errors:”

The first error resulted from…importing into subparagraph 20(1)(c)(i) a requirement that the appellant have a reasonable expectation of receiving income on account of the newly acquired shares within the first seven months of ownership of those shares. …

The second legal error flows from the Tax Court’s concern with tax avoidance…[namely] the “sole purpose of the borrowed funds [was] to facilitate an interest free loan to Wendy’s while creating an interest deduction for the Appellant”. (paras. 20-21)

The second error was addressed in Shell, where the Court indicated that such a concern could not justify departing from “the clear and unambiguous terms of s. 20(1)(c)(i)” (para. 22).

Respecting the reasonableness of the interest rate on the loan to TDL from Delcan (which she found to be deductible), Dawson JA noted that as CRA accepted that the rate was reasonable after the interest-free loan was replaced, she accepted that the rate during the seven-month period also was reasonable, and stated (at para. 26):

[T]he temporary use of the subscription proceeds by Tim’s U.S. did not detract from the appellant’s income earning purpose behind its acquisition of additional shares in Tim’s U.S.

Swirsky v. Canada, 2014 DTC 5037 [at 6723], 2014 FCA 36, aff'g 2013 TCC 73, 2013 DTC 1078 [at 431]

no objectively reasonable expectation of taxable dividends

The taxpayer transferred shares in a family real estate development company ("Torgan") to his wife ("Ms. Swirsky") on three occasions in 1991, 1993 and 1995 for creditor-proofing reasons. In the 1991 transactions, his wife borrowed $2.5 million from a trust company ("Mutual Trust") at 11% interest to pay the shares' purchase price, the taxpayer used the sales proceeds to pay off loans owing by him to Torgan, and Torgan used the proceeds to purchase a $2.5 million GIC (bearing interest at 10%) from Mutual Trust. The GIC was assigned by Torgan to Mutual Trust to secure Torgan's guarantee of the Mutual Trust loan to Ms. Swirsky. The interest on the GIC was applied by Mutual Trust to the interest owing by Ms. Swirsky on her loan, and the balance of the interest was paid monthly by Torgan and charged to the taxpayer's loan account (para. 17). The regular application of the GIC interest by Mutual Trust also apparently was treated as advances by Torgan to the taxpayer rather Ms. Swirsky (para. 44), and Paris J. rejected submissions that this treatment of the funding of the interest payments was a mere bookkeeping error (para. 45).

The interest deducted by Ms. Swirsky on her loans totaled $1.445 million by the end of 2003. In 2003 Torgan paid a dividend of $1.573 million on Ms. Swirsky's shares (and dividends also were paid in 2004 and 2005; and a $2.5 million capital dividend was paid in 1999). The taxpayer deducted the interest expenses and other carrying costs of Ms. Swirsky in computing his income by virtue of s. 74.5(1) and also included the 2003 dividend in his income.

Paris J. found that the interest was not deductible to Ms. Swirsky (and, therefore, to the taxpayer under s. 74.5(1)) because she had not borrowed from Mutual Trust for the purpose of earning income from the shares. Operating income previously had been distributed as bonuses, and Ms. Swirsky had little basis for believing that dividends would be paid. Furthermore, her subjective intentions in borrowing the $2.5 million related entirely to creditor proofing.

In the Court of Appeal, Dawson JA stated (at para. 8) that "where the purpose or intention behind an action is to be ascertained, a court should objectively determine the purpose, guided by both objective and subjective manifestations of purpose," before going on to find that Paris J (contrary to the taxpayer's submission) had in, in fact given weight to a number of objective manifestations of purpose, including that Torgan had not paid any dividends prior to 1999 (with bonuses instead being paid) nor did it have a dividend policy in place, and that it could be inferred that Ms. Swirsky instead only had a reasonable expectation of receiving a capital dividend.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Purpose/Intention no objectively reasonable income-producing purpose 83
Tax Topics - General Concepts - Onus applying GAAR at confirmation stage doesn't shift onus 63

Collins v. Canada, 2010 DTC 5028 [at 6625], 2010 FCA 12

payable refers to accrual basis/debt can be limited recourse

The taxpayers owed approximately $2.7 million on mortgage loans including substantial amounts of interest that previously had been agreed to be deferred and added to the amount of the mortgage. The mortgage loan was restructured so that the taxpayers became obligated to make annual minimum interest payments of $20,000 for each of the first 15 years following the restructuring and had the right at any time within the 15-year period to discharge all amounts on the loan by the payment of the sum of $100,000 plus all of the unpaid interest payments of $20,000 per annum. The restructuring of the loan was stated to be in the form of a refinancing of a portion of the previous mortgage debt on the terms indicated above, with a statement that these amendments did not have the effect of discharging or novating the previous mortgage obligation. For the taxation years in question following the restructuring, the taxpayers sought to deduct unpaid interest amounts that continued to be added to the original amount of the mortgage loan, namely, $154,373, $160,254 and $168,782. The trial judge disallowed the deductions on the basis that they were not "payable" in the year if they were not required to be paid in the year.

The Court of Appeal found that such unpaid interest amounts were deductible in the years of accrual. The taxpayers computed their income on an accrual basis, under which "payable" does not mean "required to be paid." Sharlow J.A. stated (at paras. 24-25):

They are entitled to that deduction even though they were not obliged to pay the full amount of the interest in the year of accrual, and even though the lender would be obliged, if the appellants exercised the settlement option, to forgive most of the obligation to pay principal and interest.

The situation is analogous to that of a limited recourse mortgage loan, where the right of the lender to recover the principal and interest is limited to the proceeds of the sale of the mortgaged property at the end of the term. Even if it is absolutely certain that the value of the property will not cover the mortgage debt, the full amount of the debt remains a legal obligation of the borrower unless and until the mortgaged property is sold.

Scragg v. Canada, 2009 DTC 6024, 2009 FCA 180

Before finding that the taxpayer had failed to discharge the onus on him to establish that money borrowed by him had been used by him to invest in companies owned by him, the Court rejected the (at para. 12) taxpayer's argument that:

"the only difference between his case and Singleton is that he did not bother with the formalities, that is, he did not withdraw his equity from his companies and replace it with borrowed money, but in substance his transaction achieves the same result."

Novopharm Ltd. v. Canada, 2003 DTC 5195, 2003 FCA 112

borrowing to receive deemed dividend

A profitable Canadian corporation ("Novopharm") acquired losses approximating $20 million of an arm's-length corporation ("Lossco") through a complicated series of transactions, which in simplified form were as follows:

  1. two special-purpose subsidiaries of Lossco formed a limited partnership ("Millbank") which borrowed $195 million from First Marathon Capital Corporation ("FMCC") and lent $195 million to First Marathon Inc. ("FMI") with FMI then immediately paying $20 million to Millbank as a prepayment of one year's interest and Millbank utilizing $20 million to pay down the principal of loan owing by it to FMCC to $175 million;
  2. Lossco acquired a 99.99% limited partnership in Millbank shortly thereafter (and immediately prior to the first fiscal year end of Millbank) thereby resulting in $20 million of income of Millbank being allocated to it, which eliminated its losses;
  3. the 99.99% partnership interest was transferred for nominal consideration by Lossco to an indirect special purpose subsidiary of Lossco ("540") and 540 then was sold to Novopharm;
  4. FMCC lent $175 million to Novopharm which used those proceeds to subscribe for shares of 540; 540 made a capital contribution of the same amount to Millbank, which paid off the $175 million loan owing by it to FMCC;
  5. a year later after $20 million of interest had accrued on the loan owing by Novopharm to FMCC, FMI repaid the $195 million principal amount owing by it to Millbank, Millbank distributed this sum to its partners (substantially 540), 540 purchased for cancellation most of the shares of Novopharm and 540 for $195 million (giving rise to a deemed dividend of $20 million), and Novopharm used the $195 million to discharge the amount owing by it to FMCC (including the $20 million of interest).

The borrowing by Novopharm to acquire shares of 540 (step 4) gave rise to deductible interest (before giving effect to former s. 245(1)) because the redemption of the shares gave rise to a deemed dividend (step 5). Rothstein J.A. stated (at p. 5200):

"The fact that the dividend received by Novopharm was a deemed dividend pursuant to subsection 84(3) is of no consequence. A deeming provision is a statutory fiction that replaces or modifies reality; and it cannot be ignored."

Stewart v. Canada, 2002 DTC 6969, 2002 SCC 46, [2002] 2 S.C.R. 645

not tainted by capital gains motivation

After finding that rental condominium properties of the taxpayer represented a source of income and that the interest expense on related borrowings was deductible, McLachlin C.J. stated (at p. 6982) that:

"The appellant's hope of realizing an eventual capital gain, and expectation of deducting interest expenses do not detract from the commercial nature of his rental operation or its characterization as a source of income"

and (at p. 6983):

"In our view, the motivation of capital gains accords with the ordinary business person's understanding of 'pursuit of profit', and may be taken into account in determining whether the taxpayer's activity is commercial in nature."

Canada v. Canadian Helicopters Ltd., 2002 DTC 6805, 2002 FCA 30

indirect eligible use

The taxpayer borrowed money from a financial institution. It on-lent $8.95 million of the borrowed funds on an interest-free basis to its parent ("Holdings") and Holdings, in turn, on-lent the funds on an interest-free basis to the parent of Holdings ("CHC") which used those funds to purchase from an arm's length vendor shares of a company ("Viking") in a similar business. Malone J.A. found that the Tax Court Judge had correctly found that interest on borrowed funds that are used directly for an ineligible use (here an interest-free loan) nonetheless may be deductible in exceptional circumstances. Here, the course of action was intended to result in benefits to the taxpayer including the earning of significant management fees and the transfer to it of operations of Viking. Interest on the $8.95 million borrowing was deductible.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Evidence 106

Dansereau v. The Queen, 2001 DTC 5642, 2001 FCA 305

The taxpayer, who was a teacher by profession, owned eight rent-producing property of which seven had to be sold, following a recession, with the shortfall between the proceeds and mortgages on the sold properties being the amount of new mortgages that the taxpayer was required to place on his remaining property.

The taxpayer was able to deduct interest on the new mortgage based on a finding that he was in a business. Given that no management fee of any sort was paid by him, it followed that he saw to the financing, rental, upkeep and improvement of the properties over the years and he pooled the income resulting from the operations. He was engaged in the business of managing and operating the properties as opposed to merely collecting rents.

Singleton v. Canada, 2001 DTC 5533, 2001 SCC 61, [2001] 2 S.C.R. 1046

The taxpayer borrowed approximately $300,000 and deposited this sum with his law firm. On the same day, he put almost exactly the same amount, received as a distribution from the firm, towards the purchase of a new home for him and his wife. It was not clear in which order the two transactions occurred.

Because the direct use of the borrowed funds was for the purpose of refinancing the taxpayer's partnership account with debt, the interest on the borrowed money was deductible. To hold otherwise would introduce an inconsistency that interest would be deductible where a partner's initial capital investment was financed with borrowed funds, but not where a partner, who originally financed with his own money, later withdrew that money for personal use and refinanced with debt.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Tax Avoidance 43

Ludco Enterprises Ltd. v. Canada, 2001 DTC 5505, [2001] 2 S.C.R. 1082, 2001 SCC 62

ancillary purpose of earning (1%-yield) dividend income/allocation of reinvested proceeds 100% to income-producing source

A group of Canadian investors, including the taxpayers, invested in the shares of two Panamanian corporations (collectively, "Justinian") whose principal activity was investing in bonds. Each year Justinian paid an annual dividend equal to 1% of the original cost of the share subscriptions in its capital. It was contemplated that the Canadian investors would receive substantially all their return as a capital gain when their shares in Justinian were redeemed (which, in fact, occurred) and that, in the meantime, the earnings of Justinian after payment of the annual dividends would accumulate free of Canadian tax.

In finding that interest (equal to approximately 10 times the dividends received) on money borrowed by the taxpayer (which was traceable to the Justinian share investment) was deductible, Iacobucci J. stated (at paras. 51, 54) that:

[A]bsent a sham or window dressing or other vitiating circumstances, a taxpayer's ancillary purpose may be nonetheless a bona fide, actual, real and true objective of his or her investment, equally capable of providing the requisite purpose for interest deductibility in comparison with any more important or significant primary purpose

...Having determined that an ancillary purpose to earn income can provide the requisite purpose for interest deductibility, ... the requisite test ... is whether, considering all the circumstances, the taxpayer had a reasonable expectation of income at the time the investment was made.

In the present case, even though deferral of income tax was the primary purpose, an ancillary purpose (objectively determined) for subscribing in Justinian with the borrowed money was the earning of (dividend) "income", which in the context of s. 20(1)(c)(i) referred not to net income, but to income subject to tax.

With respect to one of the later taxation years in question, in which one of the taxpayers disposed of its shares of Justinian to a wholly-owned subsidiary on a rollover basis in consideration for both non-interest bearing notes and interest-earning assets (principally preferred shares), Iacobucci J. found that because the value of the income-earning assets received on this transaction exceeded the amount of the borrowed money, those income-producing replacement properties could be linked to the entire amount of the loan with the result that the purpose test continued to be satisfied.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Purpose/Intention objective and subjective manifestations of purpose 98
Tax Topics - General Concepts - Tax Avoidance right to structure for tax avoidance 121
Tax Topics - Statutory Interpretation - Certainty 97

Canada v. Milewski, 2000 DTC 6559 (FCA)

The taxpayer financed virtually all of his investment in a limited partnership carrying on the business of renting apartments with borrowed money having a 25-year amortization schedule. Rothstein J.A. held that the finding of the Tax Court Judge that there was an expectation that this debt would be paid down was sufficient to establish a reasonable expectation of profit, so that the taxpayer's appeal of the disallowance of certain losses and interest expense should be allowed.

Létourneau J.A. (with whom McDonald J.A. concurred) went on to indicate (at p. 6561) that "the limited partnership was, admittedly, a viable business with a reasonable expectation of profit" and that the position of the Minister: "postulates that, as a result of the respondent's financial arrangements, the partnership in which the respondent invested did not carry on a business and was not a source of income, but only for the amount of the interest losses exceeding the income produced by the business". In this position was wrong as a matter of logic, law and common sense.

Chase Manhattan Bank of Canada v. Canada, 2000 DTC 6018 (FCA)

A subsidiary ("Leasing") of the appellant (the "Bank") had been financed with loan capital received by the Bank, which subsequently had been converted into share capital. Later, in order to shift losses to Leasing, Leasing paid a cash dividend of $45 million to the Bank which was financed, as to $36 million out of the borrowing from the Bank, and as to the balance with cash from its operations. Revenue Canada allowed the deduction of interest only on that amount of the borrowing that was matched by Leasing's retained earnings.

In confirming this treatment, Noël J.A. noted ( at pp. 6018-9) that none of the borrowed money was used to redeem or cancel the share capital, that none of the share capital was converted to debt, and that "except to the extent of the retained earnings the borrowing was not a replacement of monies that had been withdrawn for the business".

Shell Canada Ltd. v. Canada, 99 DTC 5669, [1999] 3 S.C.R. 622

borrowing in legal substance was in weak currency

The taxpayer borrowed NZ$150 million from three non-resident banks by issuing five-year debentures bearing interest at 15.40%. A comparable U.S.-dollar borrowing would have yielded approximately 9.1%. Immediately prior to the borrowing, the taxpayer entered into forward agreements with a different bank that effectively converted the NZ dollar receipts and payments into U.S. dollars, thereby locking in a foreign exchange gain on repayment of the principal.

McLachlin J. found that as the counterparty to the forward contracts was separate from the lenders under the debentures, the principal of the borrowing by the taxpayer was New Zealand dollars and should not be treated as a synthesized U.S.-dollar loan from those lenders - and the fact that the borrowed New Zealand dollars were converted by the taxpayer into U.S. dollars did not detract from the fact that all of the money borrowed under the debentures was used in the business of the taxpayer. Accordingly, interest was deductible at the Canadian-dollar equivalent of the New Zealand dollar coupons actually payable.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Substance legal relationships prevail over economic realities 193
Tax Topics - General Concepts - Tax Avoidance taxpayes entitled to rely on structure of their transactions 152
Tax Topics - Income Tax Act - Section 67 90
Tax Topics - Income Tax Act - Section 9 - Capital Gain vs. Profit - Foreign Exchange FX hedging gain was capital gain as hedged borrowing was on capital account 217
Tax Topics - Statutory Interpretation - Specific v. General Provisions 90

Singleton v. The Queen, 99 DTC 5362 (FCA), aff'd supra.

The taxpayer, who was a partner in a small law firm, withdrew $300,000 from his capital account in order to help fund the purchase of a home. Later on the same day, he borrowed $298,750 from a bank and contributed that sum, together with $1,250 of his own funds, into his capital account at the firm. In finding that the interest on the borrowed money was deductible, Rothstein J.A. noted that s. 20(1)(c), unlike other provisions of the Act, did not refer to the purpose of a "series of transactions", that under the jurisprudence reference should be made to the direct use rather than an indirect use of borrowed funds, and that if the two transactions were not to be viewed independently, an unexplained inconsistency would arise, i.e., interest would be deductible on a borrowing to finance an initial capital investment in a law firm or a refinancing of that capital investment, but not in a situation where a partner withdrew funds that he had initially invested of his own and refinanced his investment in the firm with borrowed money.

Hudson Bay Mining & Smelting Co. Ltd. v. The Queen, 99 DTC 5269 (FCA)

The taxpayer repurchased some of its outstanding debentures through brokers. The price negotiations with the vendor focussed on the price exclusive of the interest that was accruing on the debentures, with the final payment being equal to the negotiated price plus the full amount of the accrued interest. In finding that the amount so paid by the taxpayer in respect of the accrued interest was deductible, Strayer J.A. stated (at p. 5270):

"Given the fact that the appellant was the issuer of the debentures and therefore had a legal obligation to pay interest on the prescribed dates twice a year, its repurchase of them by agreement to pay that interest in advance of the repurchase date in reality involved a substitution of a new obligation by the same debtor to pay the same creditor the same rate of interest but for a shorter period. We are satisfied that the transaction of repurchase through a broker involved a mutual understanding that the rate of interest prescribed in the debenture would be paid in addition to the discounted price of the debenture, pro-rated to the date of purchase ... ."

Ludco Enterprises Ltd. v. The Queen, 99 DTC 5153 (FCA), aff'd supra

A group of Canadian investors, including the taxpayers, invested in the shares of two Panamanian corporations (collectively, "Justinian") whose principal activity was investing in Canadian bonds in accordance with the investment advice of a Canadian mutual fund manager who had moved to the Bahamas. Each year Justinian paid an annual dividend equal to 1% of the original cost of the share subscriptions in its capital. Under the planning that preceded the formation of Justinian, it was contemplated that Canadian investors would receive substantially all their return as a capital gain when their shares in Justinian were redeemed (which, in fact, occurred) and that, in the meantime, the earnings of Justinian after payment of the annual dividends would accumulate free of Canadian tax.

In determining not to allow the appeal of the taxpayers, Marceau J.A. found that the Trial Division's finding "that the appellants' true purpose in investing the two companies as structured was to defer tax and transform the income into capital gain - is a finding of fact." In concurring reasons, Desjardins J.A. stated (at p. 5332) that she agreed with the statement in the dissent reasons of Letourneau J.A. "that the taxpayer need only have had a reasonable expectation of income at the moment the investment was made, and that the borrowed money must have been used to acquire property for the purpose of deriving gross, not net, income."

Elmridge Country Club Inc. v. The Queen, 99 DTC 5127 (FCA)

The taxpayer, which was a country club that was found to be subject to tax on interest from the investment of surplus funds pursuant to s. 149(5), was not able to deduct interest on loans incurred by it from time to time to fund cash-flow shortfalls.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 149 - Subsection 149(5) 43

Laliberté v. Canada, 98 DTC 6604 (FCA)

guarantee re personal loan

The taxpayer's husband borrowed $20,000, on the security of a mortgage on a rental property, to pay legal costs in connection with a civil suit unrelated to the rental property, with the taxpayer guaranteeing her husband's loan. The taxpayer borrowed $20,000 pursuant to a second mortgage loan on the property and used the proceeds to pay off the first loan to her husband and, later, repossessed the rental property pursuant to the second mortgage. In finding that the interest paid by the taxpayer on the second mortgage loan was not deductible, Létourneau J.A. noted that the effect of the taxpayer repaying the $20,000 initial loan was to release her from her obligation as guarantor in relation to a personal loan. Accordingly, the second loan did not satisfy the income-producing purpose test.

The Queen v. Sherway Centre Ltd., 98 DTC 6121 (FCA)

A twenty-year bond financing that was secured on a shopping centre owned by the taxpayer provided for the payment, in addition to interest at a fixed rate of 9.75% per annum, of "participating interest" equal to 15% of the operating surplus (as defined) of the shopping centre in excess of $2.9 million per annum. "The 15% rate of participating interest was chosen because it was expected that this rate would increase the yield on the loan to approximately 10.25% (the prevailing market rate) provided the project reaped the benefits of inflation over the term of the loan."

The participating interest paid by the taxpayer was deductible under s. 20(1)(c). The operating surplus was capable of being allocated on a day-to-day basis and, therefore, met the test for day-to-day accrual. Furthermore, given that the participating interest was payable only so long as there was principal outstanding and the only purpose it served was to provide a rate of return on the principal that would approximate a nominal rate of interest for the loan (i.e., 10.25% per annum), the participating interest also satisfied the test that it relate to the principal sum.

Parthenon Investments Ltd. v. Canada (National Revenue), 97 DTC 5343 (FCA)

The taxpayer was not entitled to deduct interest on a promissory note that it had delivered in payment of a dividend to its parent corporation and which the parent corporation had assigned to an affiliate of the taxpayer with the taxpayer's agreement.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 125 - Subsection 125(7) - Canadian-Controlled Private Corporation control means ultimate control 133

74712 Alberta Ltd. (formerly Cal-Gas & Equipment Ltd.) v. The Queen, 97 DTC 5126 (FCA)

guarantee of parent borrowing was not made re taxpayer's income-earning capacity

The taxpayer guaranteed a loan which the CIBC made to its parent corporation ("Trennd"), for on-lending to various corporations within the group including the taxpayer. When the CIBC called on its guarantee, the taxpayer used borrowed funds to pay $1.7 million to the CIBC and received a non-interest bearing promissory note from Trennd (1979).

Linden J.A. found that the interest on the borrowing of $1.7 million was non-deductible because, applying the current-use test, the borrowed money was used to pay off the Trennd debts to the CIBC.

In his concurring reasons for judgment, Robertson J.A. found that the concession of the Minister in IT-445 - that interest paid on funds borrowed to honour guarantees given for adequate consideration, may be deducted from income even though the use of such funds has only an indirect effect on the taxpayer's income-earning capacity - had a legal foundation. However, here the consideration (in the broad sense of the word) received by the taxpayer in return for granting the guarantee was inadequate and the granting of the guarantee was intended to facilitate the income-earning capacity of the principal debtor (Trennd) and not the guarantor (the taxpayer).

Locations of other summaries Wordcount
Tax Topics - General Concepts - Purpose/Intention 51

Brill v. The Queen, 96 DTC 6572 (FCA)

Interest that accrued between January 1, 1987 and the date of judicial sale of a property whose purchase had been financed with borrowed money, was non-deductible. Linden J.A. stated (at p. 6577) that "where it is clear that no profit could be earned in the year or forever after because of the judicial sale proceedings, Moldowan is applicable".

Tennant v. M.N.R., 96 DTC 6121, [1996] 1 S.C.R. 305

The taxpayer used the proceeds of a $1 million bank loan to subscribe for common shares of an arm's length corporation ("Realwest"). After his common shares of Realwest had declined in value to $1,000, he (along with other investors in Realwest) transferred the shares of Realwest to a holding company in consideration for non-voting common shares of the holding company, thereby realizing an allowable business investment loss.

In finding that interest on the $1 million loan continued to be fully deductible following the transfer, Iacobucci J. found (at p. 6126) that "it is implicit in the principles outlined in Bronfman Trust that the ability to deduct interest is not lost simply because the taxpayer sells the income-producing property, as long as the taxpayer reinvests in an eligible use property" and noted (at p. 6127) that the alternative interpretation advanced by the Crown resulted in "an irrational asymmetry", i.e., if the replacement eligible property had a lower cost, there would be a loss of an interest deduction whereas, if the replacement eligible property had a higher cost, there would be no increase in the interest deduction.

Locations of other summaries Wordcount
Tax Topics - Statutory Interpretation - Reciprocity 64

Riddell v. The Queen, 95 DTC 5526 (FCTD)

A corporation paid the interest on a loan that had refinanced a loan received by its individual shareholder in order to finance a purchase by him of shares of the corporation. After including the resulting shareholder's benefit in the individual's income, Rouleau J. found that the individual should be entitled to a corresponding interest deduction given that the correspondence between the field auditor and his superior indicated that it was Revenue Canada's policy to allow a deduction as if the shareholder had paid the interest himself. Rouleau J. stated (at p. 5533) that "it is not open to the Minister to exercise his discretionary power to implement policy in an arbitrary and capricious fashion".

Farn v. The Queen, 95 DTC 5426 (FCTD)

Interest on mortgages owing by the taxpayers in their 1987 taxation years was found to be non-deductible given that they had defaulted on the mortgages in August 1986 and given their admission that throughout their 1987 taxation years they had no reasonable expectation of earning profit from the mortgaged properties. Pinard J. stated (p. 5435) that "it is clear to me that such properties had effectively ceased to be sources of income from at least the beginning of the plaintiff's 1987 taxation year".

Canassurance, Compagnie d'Assurance-Vie Inc. v. The Queen, 94 DTC 6186 (FCA)

The taxpayer, which was a mutual life insurance company without share capital, received subscriptions to its reserve fund from the Quebec Hospital Service Association and paid interest ("on a sporadic but constant basis") on such subscriptions at a rate of 5% per annum in those years in which it agreed with the Association that it was able to pay interest. The subscription proceeds advanced to the taxpayer were found to be loans given that the Association could not act in any other capacity than that of a lender (for example, it was not a member of the taxpayer). Furthermore, the payments of interest made in the years in question were pursuant to agreements to pay such amounts, notwithstanding that they were not reduced to written form. Accordingly, the interest was deductible.

The Queen v. Mandryk, 92 DTC 6329 (FCA)

Interest paid by the taxpayer on loans which were used to make advances to an insolvent corporation was non-deductible. In response to a submission that the taxpayer made the advances in order to protect income-producing assets from seizure by the bank, MacGuigan J.A. noted that the purpose of preserving income producing assets is an indirect rather than a direct use of funds and, therefore, is not a qualifying use.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(b) - Capital Loss v. Loss guarantee made qua shareholder 102

Bowes v. The Queen, 91 D.T.C 5310 (FCTD)

The taxpayer was unable to establish that interest on money which initially had been borrowed to acquire a personal residence later was used to finance the acquisition of a rental property. In any event, the rents from the property were approximately 1/5 of the interest expense, so that there was no reasonable expectation of profit.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Evidence 48

Livingston International Inc. v. The Queen, 91 DTC 5066 (FCTD), aff'd 92 DTC 6197 (FCA)

deductibility denied re borrowing to redeem high-low shares of Amalco

The taxpayer borrowed money from its parent in order to redeem high-low preference shares which had been issued on the amalgamation of the two predecessor corporations of the taxpayer, and later borrowed money from another shareholder corporation in order to pay off a portion of the first borrowing. Pinard J. upheld the reassessments of the Minister in which he disallowed interest on the amount of the borrowing which was in excess of the paid-up capital of the redeemed shares and the retained earnings of the taxpayer. He stated (p. 5070) that the borrowing could not "constitute within the reasoning of Trans-Prairie a replacement of capital which has already been used in the business".

Haro Pacific Enterprises Ltd. v. The Queen, 90 DTC 6583 (FCTD)

Amounts styled as "interest" which were paid pursuant to a promissory note which provided that the interest was to be paid "at such times and such amounts" as the directors of the taxpayer would decide, were non-deductible because there was no legal obligation to pay those amounts.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 97 - Subsection 97(2) capital distribution part of consideration for land contribution 145

The Queen v. Attaie, 90 DTC 6413 (FCA)

The taxpayer took out a mortgage loan to help finance the acquisition of a Toronto house. The Minister allowed the deduction of interest for the initial period during which the house was rented out, but denied the deduction of interest thereafter when the taxpayer and his family commenced occupying the house as their principal residence in June 1980. At this time, the taxpayer chose not to pay off the mortgage with $200,000 in funds which he received from Iran, because the rate of interest on the mortgage was less than what he could earn on term deposits.

Desjardins, J.A. held that because the use of the borrowed monies in the house continued, and this asset had ceased to be an income-producing one, the interest incurred by the taxpayer ceased to be deductible. The indirect use of the borrowed funds (the earning of a higher return on the term deposits) did not make an interest deduction possible.

Kalthoff v. The Queen, 90 DTC 6378 (FCTD), aff'd 92 DTC 6001 (FCA)

On March 26, 1980 the taxpayer entered into an agreement for the purchase of land for a purchase price of $525,000. The agreement provided that the final payment for the land of $425,000 was due on August 1, 1980 and that interest would accrue on this amount from April 1, 1980 to the date of payment. At the insistence of the bank, a corporation incorporated by the taxpayer ("Kal-A") acquired the lands on August 1, 1980 and executed a mortgage debenture in favour of the bank, although the interest payments actually were paid thereafter by the taxpayer.

The interest which accrued between April 1 and July 31 was deductible under 20(1)(c)(ii), notwithstanding that the taxpayer became aware on May 20 that the bank intended to make the loan to Kal-A rather than the taxpayer. However, the interest in respect of the period after July 31, 1980 was non-deductible because Kal-A rather than the taxpayer was the borrower.

The Queen v. MerBan Capital Corp. Ltd., 89 DTC 5404 (FCA)

payment under guarantee not re borrowed money

The taxpayer, which was engaged in the business of merchant banking, incorporated a subsidiary ("MKH") which in turn incorporated another subsidiary ("Holdings"). MKH and Holdings borrowed money from a bank in order to help fund the acquisition by Holdings of the shares of a public company, and the taxpayer provided the bank an indemnity (which the Crown alleged was in substance a guarantee) in respect of the payment of interest on the loans.

Iacobucci, C.J., in finding that payments made by the taxpayer pursuant to its indemnity were non-deductible, stated:

"paragraph 20(1)(c) requires that for interest to be deductible it must be paid pursuant to money borrowed by the taxpayer and not by someone else. The taxpayer must have created a borrower-lender relationship which gives rise to interest being paid ... If the taxpayer is calculating income from a source, it flies in the face of the intent and language of the Act to allow the taxpayer to deduct interest with respect to the income source of another taxpayer."

The Queen v. Malik, 89 DTC 5141 (FCTD)

Interest on loans which remained outstanding after the taxpayer sold a rental property at a loss was found, following Emerson, to be non-deductible.

Holotnak v. The Queen, 87 DTC 5443 (FCTD), aff'd 89 DTC 5527 (FCA)

The direct use of the proceeds of a loan secured by the taxpayer's rental property was the purchase of his residence, and the interest accordingly was non-deductible.

Bowater Canadian Ltd. v. The Queen, 87 DTC 5287, [1987] 2 CTC 47 (FCA)

interest incurred to acquired defaulted debt

After a company (Bulkley") in which the taxpayer and another corporation ("Bathurst") had substantial loan and share investments began experiencing financial difficulties, the taxpayer and Bathurst, at the time of the sale of Bulkley to an arm's length purchaser, agreed to equally guarantee new bank loans which replaced bank loans under which the taxpayer and Bathurst were also liable as guarantors. No payments were made by Bulkley on the new bank loans. Bathurst later acquired the remaining balance of the new notes from the banks for their principal amount and the taxpayer agreed to pay its 1/2 share of this amount to Bathurst in instalments together with interest.

The origin of this indebtedness to Bathurst was the obligations to the banks arising on the refinancing. The use test accordingly was not met, and the interest on the indebtedness to Bathurst was non-deductible. Interest on money which the taxpayer borrowed in order to prepay instalments owing to Bathurst also was non-deductible.

Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32, 87 DTC 5059, [1987] 1 CTC 117

non-deductible interest to make distribution/direct use test

Interest on money borrowed by trustees in order to make discretionary capital allocations to beneficiaries was non-deductible. Although the trustees could have instead paid the capital allocations by liquidating income-producing assets of the trust, and in this sense an indirect purpose of the borrowing was to preserve income, the court could not ignore the direct use to which the borrowed money had been put. Otherwise, the deduction of interest on borrowings for otherwise ineligible purposes, such as the making of capital gains or the purchase of speculative properties, would be permitted for any taxpayer who owned income-producing assets. "[T]he Act requires tracing the use of borrowed funds to a specific eligible use, its obviously restricted purpose being the encouragement of taxpayers to augment their income-producing potential."

Emerson v. The Queen, 86 DTC 6184, [1986] 1 CTC 422 (FCA)

The taxpayer sought to deduct interest charged on borrowed money that was used to repay a previous loan that had financed the purchase of shares. Since the shares were sold at the same time as the original loan was replaced, there was no source of income for which the interest on the replacement loan was incurred, and the deduction of that interest accordingly was denied. "[A]n essential for interest deductions [under s. 20(1)(c)] is the continued existence of the source to which the interest expense relates."

Even if the alleged indirect use could be considered, the income on the preserved assets was less than 10% of the interest on the borrowed funds.

Toolsie v. The Queen, 86 DTC 6117, [1986] 1 CTC 216 (FCTD)

The taxpayer was found to have borrowed $37,500 to acquire his residence, with the loan being secured by mortgages on two rental properties. The interest on the loan was non-deductible.

The interest payments made by the taxpayer after October 1977 were non-deductible: (1) the arrangements did not provide for the direct receipt of income by the taxpayer and the interest deducted accordingly was not applicable to its business; (2) the amount owing to Bathurst related to the guarantee given in 1972, and the "interest portion on a guaranteed loan is not interest to the guarantor"; and (3) the money was never borrowed from Bathurst and therefore was not borrowed money.

The Queen v. Terra Mining & Exploration Ltd. (N.P.L.), 84 DTC 6185, [1984] CTC 176 (FCTD)

The parenthetical expression refers to the method regularly followed by the taxpayer for financial statement purposes. Thus, where the taxpayer accounted in its financial statements for interest expense on an accrual basis in conformity with ordinary commercial practices and generally accepted accounting principles, it was precluded from computing its income for tax purposes by accounting for interest on the cash basis.

Alberta and Southern Gas Co. Ltd. v. The Queen, 76 DTC 6362, [1976] CTC 639 (FCTD), aff'd 77 DTC 5244 [1977] CTC 388 (FCA), aff'd 78 DTC 6566, [1978] CTC 780, [1979] 1 S.C.R. 36

The taxpayer borrowed $4 million (apparently at a commercial rate of interest) from its banker and paid that sum to Amoco in consideration of Amoco conveying certain working interests to the taxpayer, provided that the working interests would revest in Amoco when the taxpayer received $4 million in cash or the equivalent in petroleum substances, together with interest at 3% per annum. The taxpayer's interest expense was deductible. Cattanach, J. stated: "It is true that the interest rate on the money borrowed from its bank by the plaintiff exceeded the rate that the plaintiff received from Amoco but that does not detract from the fact that the interest the plaintifff received from Amoco was income."

The Queen v. Balmoral Holdings Ltd., 75 DTC 5296 (FCTD)

The taxpayer, one of whose objects was to provide management services to controlled corporations and which was prohibited by its objects from receiving dividends from such corporations, acquired in 1965 and 1966 all but one of the common shares of a company. The acquisition was financed, in part, from borrowed money. Collier, J. held that the taxpayer acquired the shares of the company in order to earn a management fee, and that the prohibition on the deduction of interest on money borrowed in order to acquire property the income from which would be exempt did not apply. Realistically, the taxpayer would never have caused the company to declare dividends.

Sternthal v. The Queen, 74 DTC 6646, [1974] CTC 851 (FCTD)

The taxpayer, who had a large excess of assets over liabilities, borrowed $246,800 from three private companies in which he had investments and on the same day made interest-free loans totalling $280,000 to his children. Interest on the borrowed money was not deductible. Although the taxpayer might have sold assets, loaned the proceeds to the children and then borrowed money to replace the assets, here he chose to find the money for the loans to his children by borrowing, and the fundamental purpose of the borrowing was to make those non-income-producing loans.

Byke Estate v. The Queen, 74 DTC 6585, [1974] CTC 763 (FCTD)

A company purchased by the taxpayers paid interest on money borrowed by the taxpayers to acquire its shares. The taxpayers were not permitted to deduct the interest paid by the company notwithstanding that they were assessed a s. 15(1) benefit in respect of those payments since s. 20(1)(c)(i) "permits a deduction by the taxpayer who paid the interest and not by some other taxpayer".

A similar finding was made respecting s. 20(1)(c)(ii).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 15 - Subsection 15(1) 100

MNR v. Yonge-Eglinton Building Ltd., 74 DTC 6180, [1974] CTC 209 (FCA)

In connection with the interim construction of a building, the taxpayer agreed to pay interest on the borrowed money at a rate of 9% plus 1% of its gross rental income from the building for 25 years. Notwithstanding the description of the 1% fee in the loan agreement as "interest", it was not interest because at the time it was paid and deducted, the lender had been reimbursed. "No capital being due there was no basis for the calculation of interest."

Matheson v. The Queen, 74 DTC 6176, [1974] CTC 186 (FCTD)

Interest paid by the taxpayer on a bank loan the proceeds of which had been used to refinance an interest-free loan to a controlled company ("Direct") was non-deductible. "[T]he money borrowed was used by Direct to earn income from its business rather than by the Plaintiff to earn income from his own business."

Lakeview Gardens Corp. v. MNR, 73 DTC 5437, [1973] CTC 586 (FCTD)

In 1954 the taxpayer borrowed money to acquire land inventory, and in 1962 acquired shares (generating exempt dividend income). The Minister was directed to reassess on the basis that the share acquisition was financed first out of available retained earnings, with the balance of the purchase price being financed through the existing indebtedness.

MNR v. Mid-West Abrasive Co. of Canada Ltd., 73 DTC 5429, [1973] CTC 548 (FCTD)

The taxpayer during its 1960 and 1961 taxation years borrowed $210,000 from its U.S. parent. The promissory notes stated "interest will be paid if requested, but not in excess of 6%." After the end of the 1966 taxation year, the parent requested, and was paid, interest for the period from 1962 on.

Sweet D.J. held that the phrase "in respect of the year" refers to the year during which the borrowed money was used and not to the year in which the lender chose to make the request for interest. The pre-1966 interest accordingly was not payable in respect of the taxpayer's 1967 taxation year, the year during which it sought to deduct it.

Words and Phrases
in respect of the year
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 80 - Subsection 80(1) indefinite payment arrangements for interest 74
Tax Topics - Income Tax Act - Section 80 - Subsection 80(5) 74

McLaws v. Minister of National Revenue, 72 DTC 6149, [1972] CTC 165, [1974] S.C.R. 887

guarantee obligation not borrowed money

The taxpayer provided his personal guarantee to the bank when it was threatening to call the loans it had made to a corporation owned by the taxpayer. The portion of the payments which the taxpayer later made to the bank pursuant to his guarantee that was attributable to the accrued interest due to the bank by the corporation, was not deductible under s. 11(1)(c) of the pre-1972 Act. Hall J. noted that "the interest paid by the appellant was not on an advance made to him but was paid on the principal sum remaining unpaid under his guarantee" (page 1653), and therefore was not paid on borrowed money used by the taxpayer for the purpose of earning income.

Trans-Prairie Pipelines Ltd. v. MNR, 70 DTC 6351, [1970] CTC 537 (Ex Ct)

When the taxpayer started business in 1954 it raised the capital required for its business by issuing common shares for $140,006 and preferred shares for $700,000. In 1956, the taxpayer raised $1 million by way of a bond issue for $700,000 and a common share issue for $300,000. The preferred shares were redeemed by using $300,000 from the common share issue and $400,000 out of the $700,000 received on the bond floatation.

After finding (p. 6353) that the income-producing use test refers to the dedication of "the mass of capital ... through all the different forms through which it passes while it remains in the business" rather than use in the sense of the initial payment made with money, Jackett P. went on to find that the interest on the $700,000 bond issue was deductible in full (rather than as to only 3/7 as alleged by the Crown) on the basis of the following characterization (p. 6354):

"Prior to the 1956 transactions, the appellant's capital used in its business consisted in part of $700,000 subscribed by preferred shareholders. As a result of those transactions, the $700,000 had been repaid to those shareholders and the appellant had borrowed $700,000 which, as a practical matter of business common sense, went to fill the hole left by redemption of the $700,000 preferred."

D.W.S. Corp. v. MNR, 68 DTC 5045, [1968] CTC 65 (Ex Ct), briefly aff'd 69 DTC 5203 (SCC)

The taxpayer (a distilling company) borrowed $3,485,000 from a U.S. subsidiary at 6% interest and on-lent those funds to another subsidiary ("World") in order to finance the acquisition by World of an exceptionally large quantity of unmatured Scotch fillings. Although it was agreed at the time that the taxpayer made the loan to World that interest on such loan might be a subject for later agreement, no agreement was made between the taxpayer and World for the sharing of any profits or losses on the venture or to remunerate the taxpayer for the use of the loaned money. Because there was no right accruing to the taxpayer to interest or to any other kind of remuneration, the income-producing purpose test was not met.

Société Coopérative Agricole du Canton de Granby v. The Minister of National Revenue, 61 DTC 1205, [1961] CTC 326, [1961] S.C.R. 671

"preference share" in substance a debt

In finding that a purported issuance of preference shares was in fact a loan, with the result that the interest thereon was deductible, Cartwright J. noted (p. 1209) that the share:

"provisions are entirely inappropriate to describe the rights of a holder of preferred shares; they are an unequivocal and unconditional promise to pay the principal amount received from the holder at maturity and to pay interest thereon at 5 per cent per annum half-yearly on July 15 and January 15 until the principal has been paid."

Canada Safeway Ltd. V. Minister of National Revenue, 57 DTC 1239, [1957] CTC 335, [1957] S.C.R. 717

The taxpayer, which carried on a retail chain grocery business, used the proceeds of a debenture issue to purchase the shares of a sister company which had been supplying groceries and other products to it at favourable prices and which, following the acquisition of its shares, paid dividends to the taxpayer in excess of the taxpayer's interest expense. It was found that the borrowed capital was being used to purchase shares giving rise to exempt income (dividends) rather than being used in the taxpayer's business. Rand J. stated (p. 1244):

"What is aimed at by the section is an employment of the borrowed funds immediately within the company's business and not one that effects its purpose in such an indirect and remote manner."

Interior Breweries Ltd. v. MNR, 55 DTC 1090, [1955] CTC 143 (Ex Ct)

The taxpayer used money which it had borrowed under temporary bridge financing from a bank to acquire the shares of other brewing holding-companies, and shortly thereafter used the proceeds of loans from subsidiaries of the acquired companies, and of the issuance of bonds and debentures of the taxpayer, to retire the bank indebtedness. The interest on the replacement loans was not deductible because they were used to pay off a loan which had been used to acquire shares producing exempt income. The fact that the acquisition of the holding companies enabled the taxpayer to enter into remunerative management contracts with their subsidiaries was not sufficient to establish interest deductibility.

Stock Exchange Building Corp. Ltd. v. Minister of National Revenue, [1955] S.C.R. 235, 55 DTC 1014, [1955] CTC 5

The taxpayer realized $90 for each $100 bond issued by it in 1929 and invested the net proceeds in an office building. The taxpayer was only entitled to deduct interest on the $90 actually borrowed (because it was found that the reference in s. 5(1)(b) of the Income War Tax Act to "borrowed capital" referred to the amount of money borrowed and not to the extent of the obligation incurred in order to borrow it) and was not entitled to deduct "compound" interest (i.e., default interest on simple interest that was in arrears.) The simple interest in default "was merely a debt which became payable by reason of the inability of the borrower to pay the interest as it fell due. It was not, in any sense, capital used in the business to earn the income."

Words and Phrases
borrowed capital

Minister of National Revenue v. McCool, 49 DTC 700, [1949] CTC 395, [1950] S.C.R. 80

An individual transferred the assets of his business to the taxpayer in consideration for the assumption of his business liabilities, the issuance of shares to him and family members, and the giving by the taxpayer of a demand interest-bearing promissory note. Interest on the note was not deductible by the taxpayer pursuant to s. 5(1)(b) of the Income War Tax Act, which provided for the deduction of "such reasonable rate of interest on borrowed capital used in the business to earn the income as the Minister in his discretion may allow". Kellock J. stated (p. 712):

"[I]n order to enable the statute to apply, 'there must be a real loan and a real borrowing'. Here there is nothing more than unpaid purchase money secured by a promissory note which, in my opinion, is insufficient."

Montreal Coke and Manufacturing Co. v. MNR, [1944] A.C. 126, [1944] CTC 94 (P.C.)

In connection with the retirement of old bonds and the issuance of replacement bonds, the taxpayer had to pay interest on both the old bonds and the new bonds for an overlapping period. Lord Macmillan held (at p. 134) that "the overlapping interest was paid as part of the cost of the refunding operations and on money borrowed temporarily in excess of what was required for the purposes of the businesses during the overlapping period, and was thus properly disallowed by the Minister" under s. 5(b) of the Income War Tax Act.

See Also

R. v. Golini, 2016 TCC 174

interest deduction on limited recourse loan

A family corporation (“Ontario”) used proceeds of a daylight loan to redeem shares of Holdco, which used those proceeds to purchase a life insurance policy (or, to be more precise, to purchase an annuity to fund the premiums on the acquired policy) from an accommodating offshore insurance company, with those funds making their way back, through a series of equally accommodating intermediaries, to the sole individual shareholder of Holdco (“Paul Sr.”) as a loan. This “Metropac” loan was guaranteed by Holdco, with the guarantee secured by Holdco’s life insurance policy. The loan terms limited the lender’s recourse thereunder (including to accrued but unpaid interest) to realization of such security.

C. Miller J found that the 8% interest on the Metropac loan (which he appeared to consider to be in excess of a reasonable rate of 5.5%) was deductible in full, but that there was an offsetting shareholder benefit to the extent this interest was capitalized, so that Paul Sr. only received a net interest deduction for the portion of the interest (equivalent to about a 1.33% rate) paid by him in cash. He stated (at paras. 129, 137):

What would happen on a yearly basis then is that Paul Sr. would deduct the interest payable on the Metropac loan, but coincidently would have to bring in as a taxable benefit the interest portion ultimately absorbed by [Holdco]. So, apart from his $80,000 cash payment, the inclusion and deduction would offset one another. It is therefore immaterial whether the rate is 5.5% or 8%. I conclude Paul Sr. is entitled to his $80,000 interest deduction, prorated for the 2008 taxation year. …

Given my finding of an offset, the rate is immaterial, however, if such a determination was necessary, I determine the interest rate should be 5.5%, being the rate suggested by the expert.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 15 - Subsection 15(1) a loan to a shareholder with recourse limited to an asset pledged by the corporation was a shareholder benefit 536
Tax Topics - General Concepts - Sham sham doctrine did not apply to a "minor pretence" 326
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) use of corporate asset to create PUC was abuse of s. 84(1) 244
Tax Topics - Income Tax Act - Section 84 - Subsection 84(1) policy of 84(1) 215

ENMAX Energy Corp. v. Alberta, 2016 ABQB 334

11.5% interest rate on unsecured intercompany note was reasonable under s. 20(1)(c) notwithstanding that this exceeded an arm’s length rate of around 8.5%

Enmax Energy Corporation (“EEC”) was a wholly owned subsidiary of Enmax Corporation (“EC”), which in turn was wholly-owned by the City of Calgary. EEC distributed electricity to residential and commercial customers in the Calgary area. The Payment in Lieu of Tax Regulations made under Alberta’s Electric Utilities Act provided for payments by various government-owned entities to the provincial government equal to the amount that would have been payable by them as federal and provincial income tax if they had not been exempt. EEC had borrowed $497 million from EC pursuant to an unsecured subordinated note bearing interest at 11.5% (the “2004 note”), which resulted in EEC’s capitalization being 91% debt to 9% equity. EEC was reassessed by the Alberta Minister of Finance on the basis that interest on the 2004 note in excess of 5.42% was unreasonable. Also at issue were similar loans (bearing interest at 10.3% and 9.9%) made by EEC to a wholly-owned subsidiary of EEC in 2006 and 2007, which were treated by Poelman J similarly to the 2004 note.

Poelman J found (at para. 240) that the imputed credit rating of EEC (otherwise no higher than BB-) should not:

allow consideration of implicit support to influence opinions about reasonable interest rates… . The intercompany notes allow for no parental support, because the lender and the implicit supporter are the same.

He also accepted submissions that various qualitative “fundamental factors” and savings in transactions costs should increase the benchmark arm’s length interest rate by 50 and 44 basis points, respectively, so that an arm’s length interest rate for the 2004 note might fall in the range of 7.97% to 8.77%.

After having stated (at para. 264) a Gabco-derived test as to “whether no business would have contracted to pay that amount, having only its business considerations in mind and under the form of transaction pursuant to which the obligation was incurred,” Poelman J concluded (at para. 266) that the interest on the 2004 note (as well as the 2006 and 2007 notes) was fully deductible as having a reasonable amount notwithstanding that the rate exceeded “what the evidence shows would probably have been paid under a similar arm’s length transaction.” In this regard, he stated (at paras. 267-8):

There are many benefits to a borrower in having access to all its capital requirements from its parent, some of which are intangible and difficult to quantify.

…[I]ntercompany debt is not rated… . Further… the intercompany notes were burdened with a number of conditions, such as the level of debt and stripping of cash flow to the parent, which would have made them very difficult to sell on the market without significant changes. These observations reinforce the weakness of putting too much emphasis on artificially constructed arm’s length comparators in this case. Furthermore, none of the Crown’s experts expressed the opinion that bonds comparable to the intercompany notes, without parental support, could have been sold in the market at interest rates less than those set out in the notes.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 67 Gabco test implies a range 110
Tax Topics - Income Tax Act - Section 247 - New - Subsection 247(2) arm's length comparables for intercompany interest rate not dispositive 284

Re Nortel Networks Corporation, 2015 ONCA 681

interest stops rule also applies to CCAA proceedings

Nortel proceedings under the Companies’ Creditors Arrangement Act (Canada) and Chapter 11 of the U.S. Bankruptcy Code had been on-going since January 2009. In addition to filing claims for principal and pre-filing interest of US$4.092 billion against each of the Canadian and U.S. Nortel estates, the appellant bondholders also claimed post-filing interest of US$1.6 billion. In rejecting the appellants’ submission (at para. 32) that “the CCAA filing does not affect the right to accrue interest; it only stays the collection of that interest,” so that the common law “interest stops” rule applied to deny their claim for the post-filing interest, Rouleau JA stated (at paras. 34, 37, 41):

[T]he same principles that underpin the conclusion that the interest stops rule is necessary in bankruptcy and winding-up proceedings – namely, the fair treatment of creditors and the orderly administration of an insolvent debtor’s estate - apply with equal force to CCAA proceedings. …

[I]f the interest stops rule were not to apply in CCAA proceedings, the creditors who do not have a contractual right to post-filing interest would…have “skewed incentives against reorganizing under the CCAA”… .

…[Conversely] creditors with an entitlement to post-filing interest may be less motivated to compromise… .

The TDL Group Co. v. The Queen, 2015 DTC 1098 [at 567], 2015 TCC 60, rev'd supra.

purpose of common share subscription in sub was to fund an interest-free loan by sub

The ultimate parent of the taxpayer's group ("Wendy's International") made a US$147,654,000 loan to a US subsidiary ("Delcan") at 7% interest, which then lent the money at 7.125% interest to the taxpayer. The taxpayer used the funds to subscribe for common shares of its wholly owned subsidiary ("Tim's U.S."), and Tim's U.S., in turn, lent the money interest-free back to the parent. It was intended that this be replaced by an interest-bearing note but, due to delays, this did not occur until eight months later.

Pizzitelli J upheld the Minister's disallowance of the taxpayer's interest deductions under s. 20(1)(c) during the eight-month period.

Respecting the direct use of the borrowed funds, he concluded (at para. 32) that the taxpayer did not have "any reasonable expectation of earning non-exempt income of any kind, directly or indirectly, at the time of its purchase of additional shares in Tim's U.S.," in light of its loss history, the need for cash flow to be reinvested in business expansion, and a 10-year projection showing no dividends. He also suggested (at para. 27, see also para. 31: "or even increased capital gains") that the generation of capital gains also could satisfy the income-earning purpose test in s. 20(1)(c), but that purpose also was not demonstrated.

He further concluded (also at para.32) that "the evidence clearly and unambiguously only points to the sole purpose of the borrowed funds as being to facilitate an interest free loan to Wendy's while creating an interest deduction for the Appellant."

Respecting the relevance of having regard to this intended use by Tim's U.S. of the share subscription proceeds, he stated (at paras. 26, 29):

While Singleton made it clear that there was no room to consider a series of transactions in determining the "use" of the funds ... , the determination of the "purpose" for buying the shares does not preclude looking at the indirect use of the funds or any other relevant factor. All circumstances must be considered. ...

[I]t is clear that for the "purpose" test in paragraph 20(1)(c), the use of funds by the borrower subsidiaries can be considered as part of all the circumstances.

McLarty v. The Queen, 2014 DTC 1162 [at 3556], 2014 TCC 30

revenues 10% of interest

On December 31, 1993, the taxpayer and other parties to a joint venture acquired rights to exploit seismic data in consideration for $975,000 cash and a $5,525,000 promissory note (payable only out of 50% of net licensing revenues and 20% of any production cash flow generated out of any petroleum rights acquired by the joint venture) - which the Minister conceded was not a contingent liability.

All of the interest on his share of the note incurred by the taxpayer in his 1994 and 1995 taxation years was paid out of licensing revenues, and Favreau J found that the taxpayer was entitled to capitalize those expenses as Canadian exploration expenses. In 1998 and 1998, while licensing revenues of $53,800 were generated, interest of $242,600 and $262,500 was incurred. Total licensing revenues generated in 1997 to 2006 were close to $1 million. After reciting these facts, Favreau J stated (para. 71):

This shows that the Joint Venture, despite the fact that it had ceased its exploration activities in 1996, continued to earn licensing revenues from the Seismic Data until 2006. This justifies the deduction of the interest payable on the appellant's Promissory Note in the 1998 and 1999 taxation years.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Agency participations contrary to agreement were disregarded 107
Tax Topics - General Concepts - Illegality participations contrary to agreement were disregarded 107
Tax Topics - General Concepts - Sham sham cannot apply to just part of transaction 139
Tax Topics - General Concepts - Tax Avoidance sham cannot apply to just part of transaction 139
Tax Topics - Income Tax Act - Section 67 leveraged purchase of seismic data at arm's length was presumptively reasonable 282

Doulis v. The Queen, 2014 DTC 1054 [at 2933], 2014 TCC 26 (Informal Procedure)

tax arrears interest is not a business expense

Lamarre J dismissed the taxpayer's arguments that he should be able to deduct interest on tax arrears as a business expense. Such deductions were prohibited by s. 18(1)(t).

In any event, the interest payments would not have been deductible under s. 20(1)(c). There was no borrower-lender relationship with the Crown as CRA did not agree to lend money to the taxpayer and the taxpayer instead owed tax under the Act, and there was no contractual agreement between the two parties (paras. 13-14).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(t) tax arrears interest is not a business expense 82
Tax Topics - Income Tax Act - Section 9 - Interest Income tax arrears interest is not a business expense 82

Garber v. The Queen, 2014 DTC 1045 [at 2812], 2014 TCC 1

no source required if reasonable expectation of income

The taxpayers bought units in limited partnerships, each of which was to acquire a large yacht to be used for catered vacation charters. The purported business plan for the 36 partnerships represented a "Ponzi-like scheme [which] was set to collapse eventually" (para. 344, see also 356). The unit purchases were mostly financed by the taxpayers issuing interest-bearing promissory notes, to the partnerships which were falsely represented as being intended to act as security for loans arranged by the general partner to the partnership to finance its intended business.

Rossiter ACJ found (at para. 410):

No such loans existed, and the Limited Partnerships were never capitalized. The Appellants entered into the promissory notes based on fraudulent misrepresentations, and any contractual obligation to pay interest amounts is vitiated by fraud.

Although interest on the notes thus did not satisfy the test that "there must be a legal obligation to pay interest on the amount paid or payable," the other three tests for interest-deductibility were satisfied, including the income –producing purpose test, as to which he stated (at para. 409):

[D]espite the fact that the Appellants were defrauded of their interest payments, they had a reasonable expectation of income at the time of their investment... . The Appellants' expectation of income was only in the long-term and was an ancillary purpose of an otherwise tax-motivated investment, but it nonetheless qualifies... . [emphasis in original]

A.P. Toldo Holding Corporation v. The Queen, 2014 DTC 1042 [at 2787], 2013 TCC 416

no retained earnings or stated capital

The taxpayer was a holding company for various direct and indirect subsidiaries which carried on an operating business. To resolve a shareholder dispute, it purchased for cancellation the shares of a corporate shareholder holding 12.5% of its shares in 10 tranches, each occurring on the same day. The consideration for the first five tranches was paid in cash, and for the last five tranches was paid by the issuance of an interest-bearing $20 million promissory note. The promissory note was repaid on its maturity, one year later, in cash, some of which was borrowed money.

D'Arcy J found that the taxpayer had not established that the interest on the promissory note was "paid in respect of money borrowed in the course of a money-lending business" (para. 58). Accordingly, the interest was not deductible under s. 9.

Nor could the taxpayer deduct the interest under s. 20(1)(c)(ii). This was not "an exceptional fact situation" such as in Penn Ventilator, which justified a finding of a qualifying indirect use of the shares purchased for cancellation (para. 71). Instead, the taxpayer's stated capital and retained earnings were nominal, and there was no evidence that the settled dispute had threatened its sources of income.

Collins v. The Queen, 2009 DTC 286, 2009 TCC 56, rev'd supra

The taxpayers owed approximately $2.7 million on mortgage loans including substantial amounts of interest that previously had been agreed to be deferred and added to the amount of the mortgage. The mortgage loan was restructured so that the taxpayers became obligated to make annual minimum interest payments of $20,000 for each of the first 15 years following the restructuring and had the right at any time within the 15-year period to discharge all amounts on the loan by the payment of the sum of $100,000 plus all of the unpaid interest payments of $20,000 per annum. The restructuring of the loan was stated to be in the form of a refinancing of a portion of the previous mortgage debt on the terms indicated above, with a statement that these amendments did not have the effect of discharging or novating the previous mortgage obligation. For the taxation years in question following the restructuring, the taxpayers sought to deduct unpaid interest amounts that continued to be added to the original amount of the mortgage loan, namely, $154,373, $160,254 and $168,782. In finding that these amounts were not deductible by the taxpayers in computing their income, so that the taxpayers were only entitled to deduct the $20,00 annual interest payments actually made by them, V.A. Miller, J. found that these deferred interest amounts were not "payable". She stated (at para. 29):

"I interpret the word 'payable' in paragraph 20(1)(c) to mean that the interest must be 'required to be paid' or 'due' as opposed to owing. Interest is 'payable' when there is an obligation to pay in the present as opposed to an obligation to pay in the future'."

She also indicated (at para. 38) that the amount of such interest that the taxpayer sought to deduct was not "reasonable", stating, (at para. 38):

"How could the amount of 'interest' be 'a reasonable amount in respect thereof' when it was not an amount that was paid nor was it an amount that had to be paid in the years under appeal?"

Words and Phrases
payable

Estate of Mary Rizak c/o George Jehn v. The Queen, 2008 DTC 4460, 2008 TCC 434 (Informal Procedure)

The taxpayer was unable to deduct interest on an alleged deferred obligation to subscribe for further shares in a company in which it had made an initial subscription for shares given that the only evidence of any legal obligation was a blank subscription agreement and given that (in light of the principle that interest is deductible only when it is payable, the alleged obligation to pay interest on the obligation did not arise until December 31 of a subsequent taxation year.

Tesainer v. The Queen, 2008 DTC 2807, 2008 TCC 101

Interest on money borrowed by the taxpayers to invest in a real estate partnership was found, in reliance on the decision in Moufarrège v. Quebec (Dep. Min. of Rev.), 2005 SCC 53, [2005] 2 S.C.R. 598, to not be deductible in taxation years following the sale through power of sale by the mortgagee of the real estate, on the basis that the source of income thereby had disappeared.

Lipson v. The Queen, 2006 DTC 2687, 2006 TCC 148, aff'd supra.

aff'd on other grounds 2009 SCC 1

The taxpayer's wife ("Jordanna") borrowed $562,500 from the Bank of Montreal to fund the purchase of shares of a family company from the taxpayer for $562,500. A day later, the taxpayer and Jordanna borrowed, on a joint and several basis, $562,000 from the Bank secured by a mortgage on a new personal residence that they had just purchased, with the proceeds of that loan being used to pay off the loan the Bank had made to Jordanna. The taxpayer used the share sale proceeds to pay the vendor of the residence. The taxpayer filed his return on the basis that the inter-spousal rollover applied to the share sale and that s. 74.1(1) attributed to him the loss sustained by Jordanna resulting from the deduction of the interest expense on the mortgage loan from the dividend income she received on her purchased shares.

Before going on to find that the GAAR applied to deny the deduction of the interest on the home loan, Bowman C.J. noted that if he had not reached this finding it would not have been necessary, in order to find the interest deductible, that Jordanna had paid the interest notwithstanding that the money to pay the interest came out of a joint account between her and the taxpayer, and also that Jordanna's purpose was to earn income from the shares when at the same time the purpose of the arrangement was that the income on the shares would be deemed to be the taxpayer's for tax purposes.

Crown Forest Industries Ltd. v. The Queen, 2006 DTC 2321, 2006 TCC 47

The taxpayer, which consistently had filed for income tax purposes using the cash basis for computing its deductible interest, was permitted to follow this method for purposes of the Act. The Terra Mining Exploration case (84 DTC 6185) did not give effect to the express language of the Act permitting the taxpayer to follow the cash basis and was not consistent with subsequent decisions finding that there is no unexpressed legislative intention for conformity with generally accepted accounting principles.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Stare Decisis 98

Moufarrège v. Quebec (Deputy Minister of Revenue), 2005 DTC 5605, [2005] 2 S.C.R. 598, 2005 SCC 53

Interest on loans incurred to purchase real property and shares of a company was not deductible under s. 160(a) of the Taxation Act (Quebec) (which provided that interest paid on a loan used to earn income from a business or property was deductible) given that in the taxation year in question the real property had been sold, and the company was bankrupt. Accordingly, the sources of income had disappeared.

International Colin Energy Corp. v. The Queen, 2002 DTC 2185, 2002 CanLII 47015 (TCC)

followed in BJ Services Co. Canada v. The Queen, 2004 DTC 2032, 2003 TCC 900)

The taxpayer paid a fee to a financial advisor, calculated as 0.7% of the market value of its equity and of the amount of its long-term debt net of working capital, in consideration for advice provided in connection with considering alternatives to maximize shareholders' value, with an emphasis on merger possibilities. The transaction ultimately implemented entailed the taxpayer's shareholders selling their shares, pursuant to a plan of arrangement, to another publicly-traded oil and gas company in consideration for treasury shares of that purchaser.

After finding that the fee was deductible in computing the taxpayer's income, Bowman A.C.J. went on to indicate that he found "attractive" the argument that the word "sale" in s. 20(1)(e)(i) did not refer to a sale by the taxpayer company itself (as such an event was covered by the word "issuance") and that "therefore 'sale' must imply something else and the only thing it can refer to is a sale by the shareholders in the course of a corporate transaction of the type involved here where the interests of the corporation are affected".

Hill v. The Queen, 2002 DTC 1749 (TCC)

Under a non-recourse loan owing by the taxpayer and other tenants of an office building to the non-resident landlord, 90% of the cash flow was applied first to the payment of interest and then designated and paid as rent. If the interest expense (which had been reduced to a 10% rate in the taxation years in question) exceeded the cash flow, the taxpayer could request in writing that the landlord advance the excess to him as an addition to principal, with such excess interest also being added to the principal if no such request was made. By the taxation years in question, the principal had accumulated to well over twice the value of the property.

Miller T.C.J. found that under the terms of the mortgage, the mortgagee could sue for excess interest (i.e., the difference between cash flow and the stipulated interest for the year), and the existence of the taxpayer's liability to pay the excess interest was not contingent on any future event. Accordingly, the excess interest was not contingent.

Furthermore, the payment of accumulated interest in December 1995 with such payment being advanced to the taxpayer as required under the mortgage did not result in any portion of the 1996 and 1997 excess interest being compound interest.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Payment & Receipt funds to support cheques 137
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) no Crown explanation of different treatment of simple interest 233

722540 Ontario Inc. v. The Queen, 2002 DTC 1307 (TCC)

A profitable Canadian corporation ("Novopharm") acquired losses approximating $20 million of an arm's-length corporation ("Lossco") through a complicated series of transactions, which in simplified form were as follows:

  1. two special-purpose subsidiaries of Lossco formed a limited partnership ("Millbank") which borrowed $195 million from First Marathon Capital Corporation ("FMCC") and lent $195 million to First Marathon Inc. ("FMI") with FMI then immediately paying $20 million to Millbank as a prepayment of one year's interest and Millbank utilizing $20 million to pay down the principal of loan owing by it to FMCC to $175 million;
  2. Lossco acquired a 99.99% limited partnership in Millbank shortly thereafter (and immediately prior to the first fiscal year end of Millbank) thereby resulting in $20 million of income of Millbank being allocated to it, which eliminated its losses;
  3. the 99.99% partnership interest was transferred for nominal consideration by Lossco to an indirect special purpose subsidiary of Lossco ("540") and 540 then was sold to Novopharm;
  4. FMCC lent $175 million to Novopharm which used those proceeds to subscribe for shares of 540; 540 made a capital contribution of the same amount to Millbank, which paid off the $175 million loan owing by it to FMCC;
  5. a year later after $20 million of interest had accrued on the loan owing by Novopharm to FMCC, FMI repaid the $195 million principal amount owing by it to Millbank, Millbank distributed this sum to its partners (substantially 540), 540 purchased for cancellation most of the shares of Novopharm and 540 for $195 million (giving rise to a deemed dividend of $20 million), and Novopharm used the $195 million to discharge the amount owing by it to FMCC (including the $20 million of interest).

Bowie T.C.J. found that what distinguished this case and the Mark Resources and Canwest cases from Shell, Ludco and Singleton was that in each of the former cases "an elaborate series of transactions was carried out for no other reason than to create an interest deduction in the profitable corporation, while ensuring that the corresponding yield from the borrowed funds became income of the loss company, which then passed into the hands of the profitable company as an intercorporate dividend, free of taxation".

Notwithstanding that Novopharm received a deemed dividend (see 5 above) on its investment of the borrowed funds in 540, it did not borrow those funds (see 4 above) for an income-producing purpose, and the $20 million of interest was not deductible by it.

Penn Ventilator Canada Ltd. v. The Queen, 2002 DTC 1498 (TCC)

redemption promissory note replaced PUC and R/E of redeemed shares

In order to effect a settlement of litigation brought by some of its shareholders, the taxpayer purchased for cancellation a portion of its common shares for cash and for an interest-bearing promissory note. The principal amount of the note did not exceed the aggregate of the paid-up capital and retained earnings of the taxpayer.

In finding that interest on the note was deductible, Lamarre Proulx T.C.J. indicated that although the promissory note did not represent borrowed money as required by s. 20(1)(c)(i), the test under s. 20(1)(c)(ii) was satisfied on the basis that the shares had been acquired for the purpose of gaining or producing income from the business of the taxpayer given that the promissory note replaced the paid-up capital and retained earnings that were used in the business.

Canada v. Confederation Life Insurance Co., [2001] OJ No. 2610 (Ont SCJ)

Two financial institutions purchased commercial paper in the form of discount notes which had a maturity date subsequent to the date of a winding-up date with respect to the issuer ("Confederation Life"). The note discounts were found to be interest, so that the purchasers could only claim the portion that had accrued up to the date of the winding-up order. Blair J stated (at para. 32):

Accordingly, their claims are for monies loaned to Confederation Life, plus an amount in excess of the monies advanced to reflect a consideration for the use of the monies advanced to the due date. Such a return, or consideration, is normally called "interest".

Sudbrack v. The Queen, 2000 DTC 2521, Docket: 98-2386-IT-G (TCC)

Bowman A.C.J. affirmed a reassessment of the Minister which denied 15% of the interest on a loan used to renovate a tourist guest home based on the fact that 15% of the area of the home was used as personal living quarters of the family operating the home.

Dansereau v. The Queen, 2000 DTC 1559 (TCC) (Informal Procedure)

A number of properties of the taxpayer were sold by the mortgagees under power of sale for less than the amounts owing. The mortgagees required the taxpayer to place new mortgages on his remaining rental property for the balance owing by him to them. The interest on these new loans was non-deductible because its source of income had been lost when the properties were sold.

The taxpayer was permitted to follow the cash method in computing his interest deductions because this method had always been followed by him.

Meggitt v. The Queen, 2000 DTC 1448 (TCC) (Informal Procedure)

The taxpayer argued that by borrowing to purchase her home, she was able to retain a rental property. In rejecting this argument and finding that the interest on that borrowing was non-deductible, Bowman TCJ. noted that a similar argument had been rejected in Bronfman and indicated (at p. 1450) that even if the Singleton decision "supported the appellant's position I would be obliged to follow Bronfman with which Singleton is impossible to reconcile".

Gagnon v. The Queen, 99 DTC 845 (TCC)

Bowman TCJ. indicated (at p. 849) that the fact that interest payments were made on money borrowed through non-recourse loans that were secured by an assignment of shares owned by the taxpayer was stated to be irrelevant.

C.R.B. Logging Co. Ltd. v. The Queen, 99 DTC 840, 1998 CanLII 185 (TCC), aff'd , 2000 DTC 6547, Docket: A-242-99 (FCA)

The taxpayer borrowed approximately $1.9 million from a Canadian bank and used the proceeds to subscribe for preferred shares of a company ("Meager") that used the funds to acquire the shares of the two controlling shareholders of the taxpayer. Sarchuk TCJ. found (at p. 843) that:

"There could be no realistic expectation of dividend income from the preferred shares because Meager had no income source of substance independent of the existence of C.R.B.'s business ... . In essence, CRB financed its own acquisition."

Accordingly, the interest on the bank loan was non-deductible.

Sarchuk TCJ. also noted that any income source to which the loan might have related disappeared when the preferred shares were redeemed.

Lewisport Holdings v. The Queen, 99 DTC 253, 1998 CanLII 185 (TCC)

subrogated debt acquired for income-producing purpose

After a bank crystallized two floating debentures for debts owing by a land development company and its parent, the taxpayer used borrowed money to make a payment of $2.1 million pursuant to its obligation under a guarantee and received, in return, the two debentures. In finding that the interest on the borrowed money was deductible, Teskey TCJ. stated (at p. 259) that the taxpayer "believed the value of the properties was there and based on that, made business decisions that ought not to be second guessed".

Chisholm v. The Queen, 99 DTC 150 (TCC) (Informal Procedure)

The taxpayer gifted a portion of his common shares of a family small business corporation to a trust for his children utilizing the rollover provisions of former s. 73(5) and then, approximately one month later, repurchased the shares in consideration for an interest-bearing promissory note. The trustee then issued a direction to him "to reinvest the interest payments due to the undersigned with respect to the Promissory Notes as you shall deem fit in the names of each of the children". the taxpayer was able to demonstrate that various expenditures he made on his children exceeded the amount of the interest on the notes.

In finding that no interest had been paid on the notes, Mogan TCJ. stated (at p. 155):

"In the absence of any evidence of accounting by Douglas to the trustee whereby the trustee could be satisfied that the annual interest payments had, in fact, been made and reinvested (whatever that word means) for the benefit of the children, I am not prepared to conclude that Douglas paid any interest ... ."

In any event, given that the dividends received on the shares that he repurchased were only a small fraction of the interest payable on the notes, the taxpayer was found to have repurchased the shares for the purpose of an estate plan rather than for an income-producing purpose.

Aitchison v. The Queen, 98 DTC 1956 (TCC)

The taxpayer borrowed money in order to acquire shares of a private mortgage investment corporation which, some years later, redeemed the shares, with the taxpayer using the proceeds to acquire mortgages from the corporation. Sobier TCJ. found that interest on the borrowed money continued to be deductible notwithstanding that the interest received on the mortgages was less that the interest on the borrowed money, given that the time of the redemption, the taxpayer had every right to believe that there would be sufficient income to more than cover the interest.

Canadian Pacific Ltd. v. The Queen, docket 95-3534-IT-G (TCC)

Although he would have decided the appeal on a different basis if not bound by authority, Bonner TCJ. applied the finding in the Shell Canada case to a similar set of facts in concluding that the true interest payable by the taxpayer should be an amount that represented an amortization of the gain to be realized under the forward currency purchase, and on the basis that the reasonableness limitation in s. 20(1)(c) was to be measured by reference to a reasonable rate of interest for the borrower to pay and not the rate which was reasonable for a lender to charge.

Mohammad v. The Queen, 97 DTC 5503 (FCA)

After finding that it was not proper of the Tax Court Judge to apply s. 67 to disallow a portion of the interest expense incurred by the taxpayer on the ground that the taxpayer had acquired a rental property with 100% debt financing, Robertson J.A. stated (at p. 5510):

"Certainly, the fact that a property was acquired with full financing is not a bar to deducting a rental loss, nor a ground for reducing the amount of interest that is deductible."

Integrated Wood Research Inc. v. The Queen, 98 DTC 1258 (TCC)

Before going on to find that interest accrued by the taxpayer was an expenditure for purposes of ss.194 and 37, Bonner TCJ. stated (at p. 1261):

"Firstly a transaction may be a loan even though lender and borrower do not deal with each other at arm's length. Secondly neither the presence of a high risk of default nor an actual default will convert a transaction which begins as a loan into something else or free the borrower from the obligation to pay interest under the loan agreement. Thirdly the recognition by a lender in its books of account that a receivable has become worthless does not free the debtor from its obligations under the loan agreement."

Robitaille v. The Queen, 97 DTC 1286 (TCC)

During a three-day period in 1985 the taxpayer, who was a partner in a law firm, withdrew $100,000 from his capital account, purchased a private residence for $113,500 in cash, mortgaged the residence for $100,000, and used the mortgage proceeds to restore his capital account. On January 31, 1988, he used $25,000 that he had obtained on further mortgaging his residence to make a contribution of capital to his firm while, at the same time, withdrawing $25,000 from the firm in order to make renovations to the residence.

In finding that the interest on both loans was not deductible, Dussault TCJ. stated (at p. 1292) that "investment in the law firm already existed and the purpose of the loans was only to reimburse money withdrawn and used for personal purposes a few days earlier in 1985 and on the same day in 1988".

Barbican Properties Inc. v. The Queen, 97 DTC 122 (TCC), briefly aff'd 97 DTC 5008 (FCA)

The taxpayer financed the purchase of "distressed" properties from the Royal Bank through non-recourse loans received from the Royal Bank which provided that to the extent that net operating revenue from each property was insufficient to cover the interest payable in that year, it was entitled to defer payment of the interest until the earlier of the maturity of the loan or the sale of the property. The interest whose payment, in fact, was deferred under these arrangements was not deducted by the taxpayer in its financial statements.

In affirming the denial by Revenue Canada of the deduction of the deferred interest, Margeson TCJ. found that there was uncertainty as to whether payment of the deferred interest ever would occur and that the deferred interest liability was contingent rather than a binding future liability.

WP Graphics Inc. v. The Queen, [1996] TCJ. No. 146 (TCC)

The taxpayer borrowed money in order to pay a dividend to a recent corporate purchaser of its shares which, in turn, used those monies to pay the purchase price for the shares to the individual vendors. Bowman TCJ. found that the Minister, by disallowing interest deductions by the taxpayer only to the extent that the borrowed money exceed the retained earnings of the taxpayer, had "adopted an approach that was very fair to the taxpayer".

Canwest Broadcasting Ltd. v. The Queen, 96 DTC 1375 (TCC)

The taxpayer accessed the non-capital losses of a group of arm's length corporations in financial difficulty ("FCPL") by engaging in a series of complicated transactions that resulted in the taxpayer incurring additional interest expense of $4.4 million and receiving an equal amount of preferred share dividends. McArthur TCJ. found that the purpose of the series of transactions (including the borrowing giving rise to the desired interest deduction) was reducing the taxpayer's taxes through accessing the losses of FCPL, rather than producing income. Accordingly, the interest was non-deductible.

Redclay Holdings Ltd. v. The Queen, 96 DTC 1207 (TCC)

interest not payable if contingent cash flow

Part of the consideration given by the taxpayer for the purchase by it of a partnership interest was the assumption by it of a portion of the obligations of the vendor under a debenture of the partnership containing a specific covenant to pay interest on the principal amount thereof and on accumulated unpaid interest but containing a stipulation that payments of accumulated interest, current interest and principal were payable only out of 50% of the net cash flow of the partnership. In finding that the taxpayer was not entitled to any interest deduction on the debenture for the subsequent three taxation years (in which the partnership did not have any net cash flow, as defined), Rip J. noted that the word "payable" means "a sum of money that is to be paid or is falling due" or "a sum of money when someone is obliged to pay it" (p. 1218) and that here, because the obligation to pay interest was contingent on a condition being satisfied (the earning of net cash flow), it could not be said that there was a liability in those taxation years for payment of an ascertained amount of interest.

Words and Phrases
payable
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 78 - Subsection 78(1) 81

Joy v. The Queen, 96 DTC 2026 (TCC)

The pleadings of the taxpayer, which referred to the retroactivity of the December 21, 1991 draft legislation on interest to 1972 and "submitted that this extraordinary retroactivity is due to the fact that the Draft Legislation does not change, but merely clarifies existing law", were struck out because the "Draft Legislation represented the tentative views of the Government of Canada in December 1991 and nothing more".

Vander Nurseries Inc. v. The Queen, 95 DTC 91 (TCC)

The taxpayer was found to have advanced money to an associated corporation as an interest-free loan rather than as proceeds for the redemption of preference shares held by that corporation given that the advance was recorded in this manner in its financial statement and given the relative absence of corroborative evidence (such as contemporaneous corporate resolutions) supporting characterization of the advance as redemption proceeds. Accordingly, interest on money borrowed in order to make the advance was not deductible.

Plawiuk v. The Queen, 94 DTC 1050 (TCC)

In 1987, the taxpayer borrowed a substantial sum from a supplier of a Canadian company ("Seven-Up") to acquire 100 common shares of Seven-Up under a secured loan. The taxpayer did not pay interest on the loan until an action in respect of his failure to do so was settled in 1992 when the shares were redeemed.

In finding that the taxpayer was entitled to deduct interest on an accrual basis, Sobier TCJ. noted that the taxpayer was entitled to treat different sources (i.e., his employment, his bank daily interest savings account and his leveraged investment in Seven-Up) differently in this regard.

Mutual Life Assurance Co. of Canada v. 837690 Ontario Ltd. (1993), 36 RPR (2d) 159 (Ont Ct J (GD))

The plaintiff held a mortgage which, in addition to providing for blended payments of principal and interest, also provided for the payment after each year (for which there was revenue in excess of $950,000) of an additional amount equal to 25% of the mortgagor's adjusted annual cash flow (defined as 56% of its gross revenue for the year minus its annual blended payments under the mortgage for the year). The mortgagor refused to pay the additional amounts on the grounds that they were interest and the provisions of the Interest Act had not been complied with.

In finding that the additional amounts were not interest, Scott J noted that they were only payable in a lump sum 60 days after the year if the revenue threshold for the year was exceeded (so that they did not accrue from day to day) and the fact that the blended payments of principal and interest entered into their calculation was not sufficient to establish that they bore a relation to the capital advanced. Furthermoe, a mortgage (such as the one here) need not specify expressly that additional payments thereunder are in addition to interest and principal in order for the payments not to constitute interest.

Spectron Computer Corp. v. MNR, 93 DTC 1473 (TCC)

In finding that interest costs incurred by the taxpayer to finance the payroll cost of its R & D personnel were described in s. 20(1)(c), Kempo, TCJ. stated (p. 1478):

"That no income was or could have been gained or produced at that time from the property being researched and developed is not determinative because the purpose and direct use of the borrowed funds were focused to that end and no issues were raised concerning the efficacy of the projects under research."

Mark Resources Inc. v. The Queen, 93 DTC 1004 (TCC)

loss utilization was not income-producing purpose/ gross income test

In order to utilize the losses of its U.S. subsidiary, the taxpayer borrowed funds in Canada from an arm's length bank and made a capital contribution of those funds to the U.S. subsidiary. The U.S. subsidiary purchased a term deposit from the bank bearing a lower rate of interest than that charged on the bank loan to the taxpayer and pledged the deposit to the bank as security for that loan. The interest generated by the term deposit was paid as a dividend to the taxpayer.

The interest paid to the bank was non-deductible because the absorption of business losses of the U.S. subsidiary was not a "purpose of earning income". However, Bowman J. rejected the Crown's submission that "income" in s. 20(1)(c) referred to net income as essentially defined in s. 9 of the Act. "Amounts of income such as dividends which must be included in income under paragraphs 12(1)(j) and (k) do not cease to be income merely because they are exceeded by the cost of their production."

Words and Phrases
income
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(3) 98

Lessard v. MNR, 93 DTC 680 (TCC)

The taxpayer was given the opportunity to purchase 10.25% of the shares of a private company ("Choisy") for which he worked. He accomplished this by taking out a personal loan for $83,000 at 10.75% interest, using the proceeds to subscribe for Class E redeemable shares of a corporation formed by him ("Gestion") bearing a 10% non-cumulative dividend, and having Gestion subscribe for 10.25% of the shares of Choisy. In finding that the interest on the $83,000 loan was deductible by the taxpayer, notwithstanding that no dividends were paid on the Class E shares, Tremblay J, noted inter alia that his holding of Class E shares was potentially profitable after taking into account the dividend tax credit.

Morscher v. MNR, 92 DTC 2214 (TCC)

The taxpayer, who carried on a commercial litigation practice in partnership with another lawyer, was denied the deduction of interest which Revenue Canada alleged related to partnership drawings in excess of the profit reported in the computation of income for purposes of the Act. The taxpayer was successful in characterizing the alleged excess borrowings as relating to the financing of work in progress of the partnership.

In obiter dicta, Brulé J. defined the word "interest".

Words and Phrases
interest

Glass v. MNR, 92 DTC 1759 (TCC)

The taxpayer borrowed money at prime plus 1/2% to acquire a mortgage in default which, after negotiation with the controlling shareholders of the mortgagor corporation, had its interest rate increased to prime plus 3%. The taxpayer was able to deduct his interest expense because he had a reasonable expectation of profit. However, when the mortgage was extinguished by virtue of the acquisition of the mortgaged property by a numbered company controlled by the taxpayer (which was financed through a non-interest bearing note owing to the taxpayer), the interest on the taxpayer's bank borrowing ceased to be deductible.

Goulard v. MNR, 92 DTC 1244 (TCC)

In a number of instances the taxpayer incorporated a real estate principal business corporation, arranged long-term construction bank financing for it, borrowed money from the corporation which it financed on a daylight loan basis and used the loan proceeds to subscribe for shares. Beaubier J. found that the taxpayer was entitled to deduct the interest on the loans given that the shares were purchased for the purpose of earning income by way of dividends from the shares, and given that the parties intended to create and did create a legal obligation for the taxpayer to pay interest on the borrowed money. However, interest was not deductible on loans received by him from the corporations to acquire shares to the extent that the shares were not validly issued to him.

Brown v. The Queen, 92 DTC 1105 (TCC)

borrowing to discharge guarantee

Interest on money borrowed by the taxpayer to honour his personal guarantee of his corporation's indebtedness was non-deductible. "Paying off a guarantee does not qualify as money borrowed to earn income" (p. 1106).

Sutherland v. The Queen, 91 DTC 5318 (FCTD)

Unpaid management fees owing to the taxpayer by a company in which he had an interest were found not to be a loan by him to the company in the absence of any intention on his part for the unpaid amounts to represent a loan.

Kornelow v. MNR, 91 DTC 431 (TCC)

Interest on money which the taxpayer had borrowed in order to invest in a corporation was non-deductible given that the corporation had been dissolved in a year preceding that in which the interest accrued. "If the business in respect of which the borrowed money was used for the purpose of earning income is terminated, the source is thereby eliminated and with it the right to deduct interest paid on that money in computing income" (p. 433).

Tor-Guelph Holdings Ltd. v. MNR, 91 DTC 355 (TCC)

The partners of a partnership were denied the deduction of interest on money borrowed in order to make an interest-free advance to a corporation in financial difficulty which needed the advance to enable it to pay a bank loan which was guaranteed by the partners.

Gruyich Services Inc. v. MNR, 91 DTC 159 (TCC)

Notwithstanding a comingling of funds, the taxpayer was able to establish that only a portion of borrowed money was used to pay dividends, and that the balance of the borrowed funds were used for eligible purposes. Accordingly, a portion of the interest expense was deductible.

Dockman v. MNR, 90 DTC 1804 (TCC)

The taxpayer was entitled to deduct interest on a $40,000 bank loan which he on-lent to his brother for the period of time that there was a prospect of receiving back the $40,000 lent by him plus a "bonus" (on income account) of an additional $40,000.

Interest of 20% on a second loan of $10,000 to his brother in consideration for a promise to repay a total of $11,000 was non-deductible because the $1,000 interest income portion of the promised repayment was lower than the interest expense.

Wilson v. MNR, 90 DTC 1744 (TCC)

Under a divorce settlement, the taxpayer's wife otherwise would have been entitled to shares of a company ("Taja") and other income-producing assets. In exchange for his wife releasing any interest that she might have in such assets, the taxpayer issued an interest-bearing promissory note for $300,000 to his wife, secured by a mortgage granted by Taja. The interest paid by the taxpayer was deductible under s. 20(1)(c)(ii) because "his purpose in paying the interest and eventually the principal sum of $300,000 was to secure his wife's interest in the shares of Taja ... for the purpose of gaining or producing income for himself therefrom" (p. 1747).

Lee v. MNR, 89 DTC 443 (TCC)

Only 1/8 of the interest on a vendor take-back mortgage used to finance the taxpayer's acquisition of a motel, 15.38% of the total available square footage of which was used as the taxpayer's personal residence, was non-deductible in the light of the fact that the business use of the land (e.g., for use as a driveway, parking area and swimming pool) was disproportionately higher than the square footage percentages would suggest.

Scott v. MNR, 89 DTC 218 (TCC)

The taxpayer was not entitled to deduct interest on borrowed money which he had on-lent on a non-interest bearing basis to two corporations of which he was a shareholder, which corporations used the funds to generate business income. In addition, the policy in IT-445 did not apply because the taxpayer enjoyed a distinct tax advantage in the form of using the interest expense to offset other sources of income.

Bowes & Cocks Ltd. v. MNR, 89 DTC 341 (TCC)

The taxpayer used borrowed money to acquire additional shares of its subsidiary, which the taxpayer immediately wound-up in the process of which a piece of rural land (the subsidiary's only significant asset) was conveyed to the taxpayer. The interest was not deductible because it could not be realistically said that the borrowed money was used for the purpose of acquiring the shares, and the land would not be said to have been acquired for the purpose of producing income in light of the fact that its acquisition cost far exceeded its fair market value.

Wilson v. MNR, 88 DTC 1418 (TCC)

Christie A.C.J. stated (p. 1419) that "the fact that repayment of money that is borrowed is secured by a mortgage on the borrower's personal residence does not, of itself, preclude the interest payable on that mortgage being deductible ...".

Marine Management Ltd. v. Dep. Cmmer. of Inland Rev. (Fiji), [1986] BTC 184 (PC)

It was held that borrowed money was paid by the taxpayer for the purchase of shares of a company rather than for the acquisition of a management agreement which the taxpayer intended to enter into with the company. Deductions of interest accordingly were denied because dividends on the acquired shares were exempt income.

Gilmour v. The Queen, 81 DTC 5322, [1981] CTC 401 (FCTD)

A corporation issued 3% and 3.5% debentures at discounts which resulted in effecte rates of 4.765 and 5.02% at a time whnen the prime rate of teh Bank of Nova Scotia was in the range of 5.25% to 5.5%. At isssue was whether the discounts should be deducted in calculating the corporation's undistributed income on hand account as an "expense incurred or disbursement made."

In finding that the discounts could be so deducted, Collier J found that they represented a form of prepaid interest, and Barfried did not indicate that discounts of this kind could not be a form of interest.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 84 - Subsection 84(2) 143

Re Balaji Apartments Ltd. and Manufacturers Life Insurance Co. (1979), 100 DLR (3d) 695 (Ont HC)

A mortgage provided for blended payments of principal and interest at 8.5%, and provided that "it is further covenanted and agreed" that until the principal was fully repaid the mortgagor would pay annually an amount equal to 10% of its annual revenues from the mortgaged property in excess of $135,000.

The annual participation payments were not interest for purposes of the Interest Act, because the language of the mortgage was clear that "any such payment is in addition to the payments of interest and principal. The payment is not a percentage of, or in any way related to, the principal sum." Singer v. Goldhar was distinguished on the ground that in that case "the Court had no assistance from the language of the mortgage and therefore had recourse to the principle that interest is the compensation for the use or retention of money."

Re Euro Hotel (Belgravia) Ltd. (1975), 51 TC 293 (Ch D)

The taxpayer, which was entitled to a long lease of land in consideration of developing the land, assigned its ultimate rights to the lands to a bank, which paid £1,500,000 to the taxpayer and was required to grant a long underlease of the lands to the taxpayer at a rack rent upon completion and in the mean time to make payments (which the taxpayer was not obligated to repay), to the taxpayer to finance development of the lands. When the aggregate of these payments reached £2,135,000, the taxpayer was required to pay "interest" on the aggregate amount until the granting of the underlease.

The "interest" did not qualify as "interest of money" for the purpose of a source deduction requirement.

The payments to be made are not payments made for the use of the money of another, but payments made because the Company has not proceeded fast enough with its obligations to complete the development and enter into an agreement for the grant of the sub-underlease. The payments are not compensation for delay in payment but for delay in the performance of other obligations.

Attorney General (Ontario) v. Barfried Enterprises, [1963] S.C.R. 570

The pith and substance of The Unconscionable Transactions Relief Act (Ontario), which permitted a court to re-open a money-lending transaction where it found that "the cost of the loan is excessive and that the transaction is harsh and unconscionable", was not concerned with interest, and the statute accordingly was not ultra vires.

With respect to the definition of "cost of the loan", which included "discount, subscription, premium, dues, bonus, commission, brokerage fees and charges," Judson J., after quoting a statement in Halsbury's that "interest accrues de die in diem even if payable only at intervals, and is, therefore, apportionable in point of time between persons entitled in succession to the principal," stated (at p. 575):

"The day-to-day accrual of interest seems to me to be an essential characteristic. All the other items mentioned in The Unconscionable Transactions Relief Act except discount lack this characteristic. They are not interest. In most of these unconscionable schemes of lending the vice is the bonus."

C.I.R. v. Pullman Car Co., Ltd. (1954), 35 TC 221 (Ch D)

In 1938, the taxpayer, which was in financial difficulty, replaced 70% of its preference shares by income stock which stipulated for the payment of 5% interest thereon, provided that the interest was payable only to the extent that the cumulative net profits of the taxpayer earned after September 1937 were sufficient to pay the interest.

Interest paid on the income stock in 1948, including some arrears of interest, qualified as deductible interest notwithstanding the prohibition against deducting "any payment of dividend or distribution of profits." "[H]olders of income stock are in the position of people who have lent money to the Company, and they are not proprietors nor sharers in the profits as such."

Bennett and White v. The King, 49 DTC 514, [1949] CTC 1, [1949] S.C.R. 287

guarantee payments not interest

In finding that annual amounts described in various resolutions of the taxpayer as "interest" in fact were guarantee payments, Locke J. stated (p. 515):

"Interest is paid by a borrower to a lender: a sum paid to a third person as the consideration for guaranteeing a loan cannot be so described."

Words and Phrases
interest

Inland Revenue Commissioners v. Rowntree & Co. Ltd., [1948] 1 All ER 482 (CA)

The taxpayer drew sight bills on an acceptance house which, after accepting the bills, discounted them in the market as agent for the taxpayer and remitted the proceeds to the taxpayer. The funds so received by the taxpayer did not constitute "borrowed money". Tucker L.J. stated (p. 486):

"I find it difficult, if not impossible, to appreciate how there can be borrowed money unless the legal relationship of lender and borrower exists. ..."

Reference as to the Validity of Section 6 of the Farm Security Act, 1944 of Saskatchewan, [1947] S.C.R. 394, aff'd [1949] AC 110

Section 6 of the Farm Security Act 1944 (Saskatchewan) provided that in the event of a crop failure, the principal of a mortgage on a farm would be automaticallyl reduced by 4%, but that notwithstanding such reduction, interest would continue to be payable as if the principal had not been reduced. In finding that section 6 was ultra vires as being provincial legislation in relation to interest, Rand J stated (at p. 412) that "the statute works a change of rate as the principal is diminished which...is legislation in relation to interest...." Earlier in his reasons he stated (at pp. 411-412):

Interest is, in general terms, the return or consideration or compensation for the use or retention by one person of a sum of money, belonging to in a colloquial sense, or owed to, another....

[I]nterest is referrable to a principal in money or an obligation to pay money. Without that relational structure in fact and whatever the basis of calculating or determining the amount, no obligation to pay money or property can be deemed an obligation to pay interest.

Dupuis Frères Ltd. v. Minister of Customs and Excise (1927), 1 DTC 104 (Ex Ct)

A holder of preferred shares of the taxpayer was entitled to fixed dividends and to have the shares redeemed 15 years after the date of their issuance if they had not previously been redeemed by the taxpayer out of a sinking fund that was protected from the taxpayer and its creditors. Before finding that the dividend paid by the taxpayer on the preferred shares did not qualify as interest on "borrowed capital" for purposes of s. 3(4) of the Income War Tax Act, Audette J. noted that the preferred shares were part of the authorized capital of the company, the dividends were payable out of profits only and could be passed (whereas a bond holder always had the privilege to receive the interest), in the case of the taxpayer making default in paying dividends, the preferred shareholders could not wind-up the company without the common shareholders joining in such resolution, and on a winding-up the preferred shareholders would be liable to pay the balance of any unsubscribed capital.

A. W. Walker & Co. v. C.I.R. (1920), 12 TC 297 (KBD)

A partnership borrowed £4,000 from the executors of an estate pursuant to a loan agreement which provided that the consideration for the loan consisted of "the sum of £200 per annum payable half-yearly ... and further a three-twentieth part of the profits in excess of £1,000 per annum up to but not in respect of any profits exceeding £3,000 per annum." The agreement further stated that there was no partnership between the lenders and the borrower.

Rowlatt, J., after referring to the £200 annual payments as "5 per cent interest," went on to characterize the 15% participation in profits between £1,000 and £3,000 as "simply a share of the profits." The participation payment accordingly was a non-deductible "distribution of profits" rather than deductible "interest on money" for purposes of the relevant provision.

Administrative Policy

1 June 2016 External T.I. 2015-0601211E5 - Mortgage loan from RRSP to make a shareholder loan

money borrowed by individual from RRSP to make interest-free loan to corporation

An individual, who is an RRSP annuitant, borrows the “Mortgage Loan” from the RRSP, with a principal residence mortgage granted in favour of the RRSP as security. The Mortgage Loan would be administered by an approved lender under the National Housing Act and would be insured as required by Reg. 4900(1)(j.1) by an approved private insurer. The Mortgage Loan proceeds would be used to make an interest-free shareholder loan to a corporation (the “Corporation”) in which the individual held shares and controlled, with the Corporation paying off a corporate line of credit. Is the interest on the Mortgage Loan deductible? CRA stated:

If the interest-free loan is made to a wholly-owned corporation and the Shareholder Loan is used to pay off a corporate line of credit where the interest is currently deductible by the Corporation under paragraph 20(1)(c)...such that it increases the Corporation’s income-earning capacity (i.e., by reducing the Corporation’s interest expense) and the shareholders’ potential future dividend income from the Corporation, then the interest may be deductible under paragraph 20(1)(c)… .

Locations of other summaries Wordcount
Tax Topics - Income Tax Regulations - Regulation 4900 - Subsection 4900(1) - Paragraph 4900(1)(j.1) use of qualified mortgage loan proceeds of no import 178
Tax Topics - Income Tax Act - Section 207.01 - Subsection 207.01(1) - Advantage - Paragraph (a) 4900(1)(j.1) insurance requirements generally arm's length/potential advantage on default 239
Tax Topics - Income Tax Act - Section 207.01 - Subsection 207.01(1) - RRSP Strip 4900(1)(j.1) mortgage loan unlikely to be acquired at less than FMV 217

29 January 2016 Internal T.I. 2015-0621401I7 - interest deductibility and share repurchases

interest deductible on borrowing funding a normal course issuer bid based on accumulated profits and stated capital

Canco, a listed corporation, repurchased for cancellation (the “Repurchases”) significant numbers of its Common Shares on the open market within the s. 84(6)(b) exemption, and financed the Repurchases by issuing interest-bearing notes (the “Notes”) to the public. Does a a share repurchase for cancellation (in contrast to a redemption or return of capital) qualify for “fill-the-hole” treatment as per para. 1.48 of Folio S3-F6-C1? CRA responded:

the fact that a share repurchase takes place outside the terms of the shares generally would not be relevant to the rationale for the fill-the-hole theory, namely that the borrowed funds are replacing capital previously used to earn income from a business or property. Therefore, we consider that the CRA’s position in paragraph 1.48 of Folio S3-F6-C1 that relates to a redemption of shares would also apply to a repurchase of shares for cancellation.

After describing the computation of accumulated profits (“retained earnings of [Canco] computed in accordance with accounting principles generally accepted in Canada except that the computation is made on an unconsolidated basis with investments accounted for on a cost basis and those retained earnings do not include any appraisal surplus or profits resulting from non-arm's length transactions which transform appraisal surplus into profits on a non-taxable or tax-deferred basis”), CRA also quoted Ruling 2000-005547 that:

A corporation may borrow to redeem shares issued on a transaction that was subject to an election under section 85 of the Act, to the extent of the stated or paid in capital of those shares as determined under the relevant corporate law plus the accumulated profits or retained earnings that are utilized to effect the redemption.”

24 August 2015 External T.I. 2015-0589841E5 - Financial instrument as a debt obligation

mandatory conversion on insolvency

Unsecured notes of Canco carry a fixed rate of interest, have a term of up to 60 years and upon the occurrence of default by reason of Canco's insolvency or bankruptcy, automatically rank equally with preferred stock. Would the interest be deductible? After stating that “absent a sham or a specific provision of the Act to the contrary, legal relationships are respected,” CRA stated:

the determination of whether the terms of the notes, including the preferred stock ranking clause, would prevent interest on the notes from being deductible under paragraph 20(1)(c) of the Act can only be made in the context of an advance income tax ruling request.

5 February 2016 Internal T.I. 2014-0555291I7 - Interest deductibility

Amalco (successor to Buyco) free to allocate assumed debt to retained rather than distributed Target assets

Canco 2 acquires all of the shares of Canco 3 from its parent, Canco 1, in exchange for common shares of $600 and the assumption of $400 of Canco 1 debt (the “Assumed Debt”). Canco 3’s assets are the shares of FA worth $300, and Canadian business assets worth $700. Canco 2 and Canco 3 immediately amalgamate, and Amalco immediately distributes its FA shares to Canco 1 as a return of capital. Does the interest on the Assumed Debt remain deductible?

After noting that “assumed debt can be considered to be an amount payable for property acquired,” and that “one can look to the assets of Canco 3 that become assets of Amalco in order to satisfy the purpose test under subparagraph 20(1)(c)(ii) in respect of the Assumed Debt,” the Directorate stated:

If any part of the Assumed Debt is allocable to the FA shares then, after the FA shares are distributed as a return of capital, we would likely take the position that a portion of the interest is not deductible on the basis that there would be no property substituted for the FA shares… .

However, …taking into consideration the flexible tracing approach mandated… in Ludco…as well as the comments in paragraph 1.38 of the Folio…Amalco would be entitled to allocate the entire amount of the Assumed Debt to its assets other than the FA shares. Thus, the interest payable by Amalco on the Assumed Debt would be deductible under subparagraph 20(1)(c)(ii) after the distribution of the FA shares to the extent that the remaining assets are capable of producing income from property or from a business.

9 October 2015 APFF Roundtable Q. 11, 2015-0595771C6 F - Deductibility of interest in a leveraged buyout

CRA non-committal on interest deductibility where only the indirect use of borrowed funds is to acquire Target’s shares

When asked about interest deductibility where, in the context of a leveraged buy-out, the Bank lends to Target under a secured loan bearing interest at 5%, Target lends the same sum to Acquireco at 5.5% interest, and Acquireco uses the same sum to purchase all of the shares of Target, CRA stated:

The submitted situation is not a typical leveraged buy-out structure. It instead more resembles… C.R.B. Logging… . We are not currently disposed to take a position respecting such a hypothetical scenario, but would be prepared to consider this question in the context of an advance ruling request.

9 October 2015 APFF Financial Strategies and Financial Instruments Roundtable Q. 3, 2015-0588951C6 F - Deductibility of interest – ss. 20.1(1)

no source disappearance where interest-free advance to sub is forgiven

The sole shareholder of a CCPC uses borrowed funds to make an interest-free advance to the CCPC, and the CCPC then makes a proposal under the BIA, which is accepted by the creditors and entails the shareholder advance being cancelled. CRA considered that “the actual use of borrowed money, following the debt cancellation, continues to be for the purpose of investing in the shares of the corporation,” so that if “there is a reasonable expectation of deriving dividends,” the interest payable by the shareholder would continue to be deductible under general s. 20(1)(c)(i) principles without the need to resort to the s. 20.1(1) rule for source extinctions.

11 September 2015 Internal T.I. 2015-0586301I7 - Premiums received on re-opening of debt

denied interest expense where a premium was received on extending notes’ maturity

The Taxpayer, a corporation whose business was not that of borrowing or lending money re-opened (i.e., extended the maturity of) notes on a private placement basis. Re-opening the notes resulted in fewer costs being incurred as compared to a fresh offering. Did the receipt of a premium on the re-opening cause a portion of the interest on the notes to be considered to be unreasonable as per S3-F6-C1, para. 1.96 (formerly IT-533, para. 38)? The Directorate responded:

[T]he Taxpayer issued the Notes with a stated interest rate in excess of a rate that would have been required in the market at the time the debt was re-opened. The premium on the Note arose in exchange for the excess rate of interest and served to adjust the overall yield to reflect the market yield.

…[T]he interest deduction…is unreasonable in these circumstances. …[As per] IT-533…“the interest expense will be reduced over the life of the debt with reference to the amount of the premium.”

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 14 - Subsection 14(5) - Cumulative Eligible Capital - Element E premium received on note re-opening subject to eligible capital amount treatment if not otherwise taxable 152

25 May 2015 External T.I. 2014-0563351E5 - Mandatory conversions and interest deductibility

notes with mandatory conversion on insolvency

Notes of a Canadian corporation ("Canco") with an investment grade rating would carry a fixed rate of interest, be denominated in Canadian dollars, have a term of up to 60 years and be unsecured. Upon the insolvency or bankruptcy of Canco, the notes would automatically be converted into cumulative preferred shares with full stated capital in accordance with a pre-established conversion ratio. Would the mandatory conversion clause cause the notes to be considered as not representing "borrowed money," so as to preclude a s. 20(1)(c) deduction? Before indicating that there were insufficient facts to answer, CRA stated:

Generally, a borrower lender relationship exists if the lender will be able, at a given time, to enforce repayment of the amount advanced, either by receiving the cash itself or property having an equal value. Where a mandatory conversion feature such as the one described above is triggered, the lender may be obligated to accept property on a settlement of the debt obligation that has a value that is less than the funds initially advanced.

[R]ulings relating to paragraph 20(1)(c)… have been issued in respect of interest on debt, the terms of which included a mandatory conversion feature… [where] the triggering events … were considered to be remote … . Such triggering events were limited to events such as bankruptcy or insolvency. Other factors taken into account…included whether the triggering events were outside the control of the debtor, the purpose of the mandatory conversion clause, the terms and type of shares to be issued on the conversions, the nature of the debtor's business and industry, and whether the debtor and the creditors would be dealing at arm's length.

2014 Ruling 2014-0523691R3 - Non-Viable Contingent Capital

non-viable contingent capital sub debt of bank respected as non-participating interest debt

Aco, a public corporation, will issue (at no discount or only a shallow discount) the "Notes" which: will rank equally with its other unsecured debt; will bear interest at specified fixed or floating rates, will not (in the case of the fixed rate Notes) be redeemable before the first interest reset date (except on the occurrence of specified events) and will be automatically converted into common shares based on a predetermined conversion formula (presumably at the point of non-viability as defined by OSFI, subject to regulatory discretion), so that there is no assurance that the conversion formula would result in the issuance of common shares having a fair market value at least equal to the principal.

Rulings

S. 20(1)(c) deductibility of interest (subject to standard conditions) - summary states that "a borrower and lender relationship ... exists until such time as a mandatory conversion event occurs ... [and] the mandatory conversion event is remote;" interest is not participating debt interest.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(3) - Participating debt interest non-viable contingent capital sub debt of bank respected as non-participating interest debt 132

20 January 2015 Internal T.I. 2014-0551121I7 F - Interest deductibility

deductible interest incurred before amalgamation not paid until thereafter

Canco 2, 3 and 4 were wholly-owned by Canco 1. Cancos 3 and 4 used the proceeds of loans from Canco 2 in 2010 for an income-producing purpose. In 2011 the principal was repaid but the accrued but unpaid interest remained outstanding. Immediately before the end of their 2011 taxation yearsCancos 2, 3 and 4 amalgamated. Did the fact this interest was not paid before the amalgamation detract from its deductibility? Before concluding that the interest was deductible, the Directorate stated (TaxInterpretations translation):

[T]he term "payable" in paragraph 20(1)(c)…refers to "accrual accounting" if that method is regularly followed by the taxpayer. … [W]e presume that Canco 3 and Canco 4 used the accrual method... . That being the case, the deduction permitted to Canco 3 and Canco 4 for a particular year corresponds to the amount of interest incurred.

S3-F6-C1 - Interest Deductibility

1.1 "Interest". "Interest" accrues daily, is calculated on principal and is compensation for its use.

1.2-1.4 Participating interest. Subject to Sherway, participating interest generally is not interest.

1.15. Limited-recourse debt. Interest is not contingent by reason only of recourse being limited.

1.20 Reasonable amount. Prevailing yields should be considered.

1.22-1.24. Loan v. unpaid amount. Unpaid purchase price (engaging s. 20(1)(c)) implies a seller-purchaser relationship, while a loan (engaging s. 20(1)(c)(i)) requires a lender –borrower relationship.

1.25-1.27. Purpose test. Ludco indicates that an ancillary purpose to produce gross income is sufficient.

1.33-1.34. Direct tracing. A taxpayer can generate an interest deduction by retiring ineligible debt with proceeds of income-producing property, then reborrowing to acquire that asset, or by using cash damming.

1.38-1.39. Flexible linking. Where property acquired with borrowed money is replaced with personal and business assets, the loan can now be allocated on a dollar-by-dollar basis to the replacement properties; but where their FMV is less than the loan, pro-ration of the borrowed money is required.

1.40. PUC distributions. Interest on borrowings to fund PUC distributions is non-deductible unless the proceeds are used for an eligible purpose.

1.42. Commingling. "[W]here borrowed money and other money is commingled, taxpayers may choose the uses of the borrowed money from all of the uses of the money." A borrowing cannot be linked to a subsequent-day transaction, and this flex approach cannot be used "where a single borrowing account (such as a line of credit, mortgage or loan) is used for eligible and ineligible purposes."

1.44 Amalgamation/winding-up of target. Direct and current use is established where a target acquired with borrowed money is wound-up or amalgamated.

1.48-1.53 Indirect use. The purpose test will be satisfied if borrowed money to redeem shares or return capital replaces contributed capital or accumulated profits, a similarly re borrowed money to distribute accumulated profits or partnership capital (generally as measured in the capital account).

1.55-1.57. Interest-free loans. Generally, a deduction for interest will be allowed if borrowed money is used to make an interest-free loan to a wholly-owned corporation (or in cases of multiple shareholders, where shareholders make an interest-free loan in proportion to their shareholdings) and the proceeds have an effect on the corporation's income-earning capacity. However, interest was denied to make a cross-border contribution of capital in Mark Resources.

1.58 Employees. "Generally, a deduction for interest would be allowed where borrowed money is used to make an interest-free loan to employees in their capacity as employees [but not shareholders]."

1.62 Assumed debt. "[I]f a taxpayer has assumed another person's indebtedness as part of the purchase price of an asset acquired by the taxpayer, the taxpayer will have an amount payable for property acquired… under subparagraph 20(1)(c)(ii)."

1.63.1 Substituted use on amalgamation or winding-up. "...Where a corporation acquires the shares of another corporation in exchange for an assumption of debt or a note payable to the vendor, the CRA would consider the shares that were initially acquired (and have disappeared) to have been substituted for assets formerly held by the acquired corporation that has been wound-up or amalgamated. These assets would then be tested for an eligible purpose."

1.63.2 Linking of debt to remaining eligible assets. "In situations such as those in ¶1.63.1 but where the debt represents only partial consideration for the share acquisition, if some assets do not meet the purpose test, the taxpayer may adopt a flexible approach in linking the debt to the eligible assets formerly held by the acquired corporation... . Similarly, if some of those eligible assets are subsequently distributed as a dividend or a return of capital, taxpayers would be entitled to link the debt to any remaining eligible assets... ."

1.64. Different "purpose" wordings. In light of the French version, "purpose of gaining or producing income" in s. 20(1)(c)(ii) means the same as "purpose of earning income" in s. 20(1)(c)(i).

1.65 Penn Ventilator. Consistently with Penn Ventilator interest on a note issued to redeem shares may be deductible under s. 20(1)(c)(ii), whereas "interest on notes issued to pay dividends or to return capital would not qualify."

1.69. Negative spread. "Based on Ludco, where an investment carries a stated interest or dividend rate, the income-earning test will be met ‘absent a sham or window dressing…'…."

1.70. Common shares. "If a corporation has asserted that it does not pay dividends and that dividends are not expected to be paid in the foreseeable future such that [common] shareholders are required to sell their shares in order to realize their value, the purpose test will not be met. However, if a corporation is silent with respect to its dividend policy, or its policy is that dividends will be paid when operational circumstances permit, the purpose test will likely be met."

1.72 Affiliated but not related. In a loss shift between unrelated corporations, they must be affiliated using the same (i.e., de jure control) criteria as in s. 69(11).

1.73. Positive spread. "In the context of a loss consolidation…there should be a positive spread between the dividend yield on the preferred shares acquired with the borrowed funds and the interest rate on that debt."

1.74. Non-blatant loss-shift transactions. "The transactions that are undertaken must not be blatantly artificial… ."

1.78-1.80 Guarantees. Although where providing guarantees is not part of the taxpayer's business, the direct use of money to honour a guarantee does not qualify, the taxpayer may be able to demonstrate an indirect use, for example, "where a parent company guaranteed the debts of its wholly owned subsidiary (or in cases of multiple shareholders, where shareholders guarantee a loan in proportion to their shareholdings) and can show that it reasonably expected to earn income from the transaction…[[e.g.] increased future dividend income…[or] as in Lewisporte…[where] the purpose of the borrowing to honour the guarantee was to obtain complete control over all the assets of two subsidiaries… ."

1.82 Interest to pay interest. "Interest… on a second loan that is used to pay interest on a first loan, is deductible…if the interest on the first loan is deductible… ."

1.83 Interest on capitalized interest. [W]here accrued interest is added to the outstanding principal amount of an existing loan resulting in a new obligation or novation, an interest payment will not be considered to have been made. A portion of the interest charged in respect of the new loan will constitute compound interest and may only be deductible under paragraph 20(1)(d) in the year it is paid.

1.96 Reduction based on loan issuance premium. Where [loan issuance] premium arises because the debt was deliberately priced to give rise to a premium, the interest expense otherwise deductible will not be considered reasonable. As such, the interest expense will be reduced over the life of the debt with reference to the amount of the premium.

1.97 Allocation of credit card interest. Generally, it should be possible to allocate the interest on credit card balances between personal and business use. "[W]here this cannot be done, the CRA will allow the interest to be apportioned according to its use (business vs. personal) based on the proportion of total business charges to total personal charges on the credit card for the period in question."

2 December 2014 CTF Roundtable, Q2(a)

positive spread/independent servicing source in loss consolidations

In a loss consolidation arrangement, "Lossco," which has non-capital losses, lends money to Profitco at a reasonable stated rate of interest and Profitco in turn uses the inter-corporate debt to acquire preferred shares of Lossco. Does the CRA require a positive spread between the dividend yield on the preferred shares acquired with inter-corporate debt and the interest rate on that debt, and must the dividend payor have an independent source of income to pay the dividends? CRA stated:

[I]t is the CRA's policy not to provide rulings without a positive spread between the interest paid and the dividends earned. …[I]n circumstances of upstream shareholding in which a subsidiary acquired dividend paying preferred shares of the parent…[o]ur views… expressed in Income Tax Technical News No. 30…[are], "The key criteria to be met in such situations is the existence of other assets in the parent company that can generate sufficient income to pay the dividends on the preferred shares held by the subsidiary."

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 111 - Subsection 111(1) - Paragraph 111(1)(a) positive spread/independent servicing source in loss consolidations 165

10 October 2014 APFF Roundtable, 2014-0538261C6 F - Disposition of capital interest/personal trust

non-deductible interest on note issued to beneficiary

In order to settle the capital interest in a discretionary family trust of a beneficiary who is related to the trustees, that beneficiary agrees to renounce his interest in consideration for $200,000 paid as to $50,000 in cash and as to $150,000 by the issuance of a promissory note due in 5 years' time and bearing interest at 5%. Would the interest on the note be deductible? CRA responded (TaxInterpretations translation):

The interest calculated on the $150,000 note would not be deductible in accordance with the provisions of subparagraph 20(1)(c)(i) as there is no borrowed money... .

[Respecting] subparagraph 20(1)(c)(ii)…even if it were possible from a legal perspective to conclude that the note ... represented "an amount payable for property," ... it would not be possible to conclude ... that any "amount payable for property" was "for the purpose of gaining or producing income from the property." ...

[T]he reasoning in [Penn Ventilator] does not apply here. We also refer you to the comments ... in Bronfman Trust ... where, in similar circumstances ... the Court refused to consider the indirect use criterion in its decision.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - 101-110 - Section 107 - Subsection 107(2) issuance of note by trust is not distribution of trust property 72
Tax Topics - Income Tax Act - 101-110 - Section 108 - Subsection 108(1) - Cost Amount note issuance is not trust property distribution to a beneficiary 201

9 April 2014 Internal T.I. 2014-0519231I7 - Debt forgiveness and guarantees

interest on guarantee obligation non-deductible

Forco, a wholly-owned subsidiary of Canco, borrowed under a secured "Borrowing" from a lending syndicate, with Canco providing a guarantee" secured by, inter alia, its shares of Forco and with no fee being charged by it. Canco also guaranteed various contractual obligations of Forco. Forco became insolvent, both guarantees (the "Guarantees") were called and Canco commenced CCAA proceedings. There was an insufficiency after a sale of Forco, and Canco defaulted on its Guarantees.

In finding that s. 80 did not apply in respect of the forgiveness of amounts owing by Canco under the Guarantees, the Directorate noted (respecting s. 20(1)(c)(i)) that "Canco should not be considered to have borrowed money under the Borrowing" and (respecting s. 20(1)(c)(ii)) "the amounts owing by Canco were not amounts payable for property acquired for the purpose of gaining or producing income from property." Accordingly, the Guarantee obligations were not commercial debt obligations.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 80 - Subsection 80(1) - Commercial Debt Obligation guarantee obligation not a commercial debt obligation 149

12 February 2014 Internal T.I. 2012-0443391I7 - cross-border loans and deductibility of interest

interest deductible when satisfied with common shares issued in pre-FAD-rule foreign afiliate dumping transactions

Canco purchased common shares of Foreign Sub (a subsidiary of Parentco) from its foreign parent (Parentco) in consideration for treasury shares. Parentco then subscribed U.S.$XX for a Term Debenture which (guessing): was governed by U.S. law; and provided that the stipulated interest could be satisfied by Canco issuing common shares (which in fact occurred in the second subsequent year to each year in which the interest accrued.) With funds received from the issuance of shares to Canco, Foreign Sub purchased all of the outstanding shares of MCo from a third party. Foreign Sub merged with MCo immediately thereafter. The TSO indicated "that the purpose of the transactions, as structured, leading up to the acquisition of MCo, is to obtain the tax benefit available in Canada from the interest deduction."

At the conclusion of a general discussion on interest deductibility (including a statement that "CRA has accepted that a payment could constitute interest in a situation where interest paid on a percentage of net cash flow is subject to an overall limiting percentage of the principal sum of the debt that represents a commercial rate of interest,") the Directorate stated:

The CRA has provided favourable rulings that the borrower-lender relationship was not invalidated with respect to long-term debts if in the terms of the loan there was sufficient obligation for repayment at the maturity date. …[T]he features described … in [the documentation], in and of themselves, would not cause the interest on the borrowed money to not be deductible... .

2013 Ruling 2013-0490341R3 - No-type of property spin-off butterfly

post butterfly FX loan by TC to DC

Preliminary/butterfly reorg

The shareholders of Old Pubco (a Canadian public corporation dealing at arm's length with each shareholder) will transfer all their Old Pubco common shares to a newly-incorporated Canadian subsidiary of Old Pubco (New Pubco) in consideration for New Pubco common shares. Old Pubco will then effect a butterfly spin-off to Newco of the Spin-off Properties (being shares of various non-resident subsidiaries), so that immediately following such spin-off Newco and Old Pubco will be wholly-owned by New Pubco. See summary under s. 55(1) - distribution.

Creation of debt between two Pubcos

New Pubco will draw down under the "New Pubco Multicurrency Credit Facilities" and use the proceeds to lend at a small spread to Old Pubco (under the "Old Pubco Internal Multicurrency Debt"), and Old Pubco will use such proceeds to pay off the "Old Pubco Multicurrency External Debt." "Simultaneously, Old Pubco will enter into an internal hedging contract ("Hedging Contract 2") with New Forco Holding 2 [included in the Spin-off Properties] to mitigate foreign exchange exposure in respect of the Old Pubco Internal Multicurrency Debt.

Ruling

: re interest deductibility on the Old Pubco Internal Multicurrency Debt "to the extent the Old Pubco Multicurrency Internal Debt does not exceed the PUC of the Old Pubco New Preferred Shares, determined immediately before the redemption."

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution s. 55(3.02) public spin-off of CFAs to new sister TC with post butterfly FX loan by TC to DC; new public corp inserted above DC before b/f 399

2013 Ruling 2011-0395091R3 - MFC to MFT Conversion

deductible interest on internal assumption (no release)

underline;">: Background. Taxpayer, which is a listed mutual fund corporation, wishes to convert to a mutual fund trust (so that following the conversions transactions its remaining assets will be nominal).

Transaction overview

Taxpayer will settle a subtrust with modest assets, and distribute the units of the subtrust to its public shareholders, who thus will now hold assets of a "good" mutual fund trust ("REIT #1"), albeit with nominal assets. Next, Taxpayer will merge into REIT #1 under s. 132.2, so that REIT #1 is now the successor to substantially all its assets. However, it will not be released under its covenant under convertible debentures (the Debenture), which will be assumed by REIT #1 only on an "internal" assumption.

Rulings

under s. 20(1)(c) re the assumed obligation of REIT #1 (and re interest obligation of Taxpayer on legally retained Debentures).

See detailed summary under s. 132.2 – qualifying exchange.

3 June 2013 Internal T.I. 2012-0468131I7 - Participating debt interest

deductible interest on subordinated convertible debt with participating interest payble in prefs

The Canadian taxpayer issued Contracts to its wholly-owning non-resident parent ("ForParent") as consideration for its purchase from ForParent of shares. The Contracts:

  • were convertible at ForParent's discretion into common shares of the taxpayer at a fixed conversion rate
  • were subordinate to all senior indebtedness
  • bore "Aggregate Amounts" comprised of "Fixed Amounts" and "Variable Amounts"
  • the Fixed Amounts were determined by applying the Government of Canada yield rate for 30-year bonds plus X basis points to the Contracts' Face Amount
  • the Variable Amounts were determined as the lesser of X% of the Face Amount and a fraction of adjusted non-consolidated net income of the taxpayer
  • the Aggregate Amounts could be paid at the discretion of the taxpayer by the issuance of preferred shares of the taxpayer

ForParent classified the Aggregate Amounts "as distributions from hidden capital contributions" for its tax purposes so that it was not subject to local income tax, net worth tax or municipal business tax respecting the Contracts. The taxpayer withheld and remitted Part XIII tax on its payments of the Aggregate Amounts at the Treaty rate applicable to interest.

CRA noted that:

None of ForParent's ability to convert the ... Contracts into Common Shares of the Taxpayer, the Taxpayer's ability to satisfy the Aggregate ... Amounts payable through the issuance of Preferred Shares, nor ForParent's classification of the amounts received for XX tax purposes as distributions from a hidden capital contribution indicate the presence of an equity investment for Canadian domestic tax purposes.

On this basis and in light of Sherway Centre, the Aggregate Amounts represented deductible interest to the extent that:

[E]xpressed as a percentage of the relevant Face Amount [they] ... reflect commercial interest rates between parties that are at arm's length at the time when the…Contracts were executed.

27 February 2013 External T.I. 2013-0477601E5 - Interest Deductibility on Restructured Borrowings

interest deduction can be structured

When asked us for clarification as to why in The Queen v. Singleton, 2001 SCC 61, the interest deduction was allowed whereas in the Lipson v. The Queen, 2009 SCC 1, the deduction was not allowed, CRA confirmed that in Lipson:

[T]he Court did not change its conclusion from that in Singleton; in Lipson the Court still made it clear that, providing that the provisions of the Income Tax Act are appropriately adhered to, a taxpayer can generally arrange or rearrange his or her affairs so as to be entitled to deduct interest on debt.

12 June 2012 June STEP Roundtable, 2012-0449811C6 - Application of 20(1)(c) if 75(2) applies

An individual (the "Borrower") uses borrowed money to purchase an income producing property and later settles this property on an inter vivos trust, to which s. 75(2) applies to attribute income earned on the property back to the Borrower. CRA states:

provided that the Borrower continues to have a legal obligation to pay interest on the borrowed money, and that the trust continues to hold the Initial Property for the purpose of gaining or producing income which, pursuant to subsection 75(2), will be attributed to the Borrower, a deduction pursuant to paragraph 20(1)(c) may be claimed equal to the lesser of the interest paid in the year or payable in respect of the year (depending on the method regularly followed by the Borrower) or a reasonable amount thereof.

2012 Ruling 2011-0431101R3 - Cross-border spin-off butterfly

interest deduction following b/f cross-redemption

On a butterfly reorganization, the non-resident parent of the distributing corporation (DC) exchange its common shares of DC for new common shares and DC Special Shares, and then transfers its DC Special Shares to the transferee corporation (TC) in consideration for TC common shares. On the subsequent butterfly transfer of assets by DC to TC, the consideration includes the assumption of liabilities as well as the issuance by TC of preferred shares. However, a portion of the indebtedness of DC is not assumed. The preferred shares of TC and the DC Special Shares are then cross-redeemed.

CRA rules that interest on DC's retained debt will be deductible (subject to the more usual qualifications) to the extent that its aggregate amount does not exceed the contributed capital and accumulated profits of the DC Special Shares which were redeemed. (Ruling K)

13 August 2012 Internal T.I. 2012-0453481I7 - Accumulated Profits

instalment payments of dividend in excess of accumulated profits

A subsidiary of Canco ("Subco") declared a dividend payable to Canco immediately following a time at which it accumulated profits ("AP") were $X, and thereafter Canco declared a dividend (the "Canco Dividend") payable to its parent ("Parentco"), with its AP immediately before that time, including its share of partnership income for completed fiscal periods, being less than the amount of the dividend. The payment of the dividend by Canco to Parentco was accomplished through five circular transactions each beginning with Parento drawing down on a line of credit and ending with Parento paying down that line of credit. This occurred because "Canco was prohibited by real economic factors from paying off the Canco Dividend in one payment."

CRA stated:

the better view is that where a dividend in excess of APs is paid in instalments, each dollar used to reduce the dividend payable would first go to the fill the hole created on the declaration of the dividend, followed by the payment of the portion of the dividend, if any, in excess of APs.

15 August 2012 External T.I. 2012-0446741E5 - Interest Deductibility

disappearing source on redemption

An individual who is the shareholder of a corporation borrows money from a financial institution to acquire preferred shares of the corporation with a dividend rate of X%. The corporation subsequently makes a distribution of capital to the individual, who uses such funds for personal (non-investment) purposes.

After stating that "interest on money borrowed to acquire preferred shares with a stated dividend rate will generally be deductible by an individual for income tax purposes," CRA went on to state that

in the given situation, it is our view that the income-earning purpose of the borrowed money would no longer be met; as the capital is immediately returned to the shareholder, the borrowed money is not used in the corporation's business. Interest on the loan would therefore not be deductible since the "current use" of the borrowed funds is personal rather income-earning.

12 March 2012 Internal T.I. 2011-0398721I7 - Interest expense deduction

post-judgment interest

Two creditors provided financing for the purchase and development of land and building held by nominee corporations, with the beneficial ownership held by the two individual taxpayers as equal tenants in common. Such financing was secured by mortgages and guaranteed by the taxpayers. After default, the creditors took action against the taxpayers in their capacity of guarantors, and the Ontario Court of Justice ordered the corporations as well as the guarantors to pay the amounts owing (after deduction of the value of the properties, which had been seized by the creditors) as well as post-judgment interest.

CRA was of the view that this post-judgment interest was not deductible interest as the judgment was "neither a second loan nor a continuation of the initial loan," and "a taxpayer, who makes a payment under a guarantee of indebtedness of a corporation, will generally be considered to have acquired the rights of the creditor in respect of the indebtedness at the time of payment," so that the "Judgment amount to be paid by the Taxpayers as guarantors, is not considered to be a borrowing of the Taxpayers."

However, if the taxpayers borrowed money in order to pay the judgment, then it was possible that the interest on that borrowing would be deductible if the guarantee was given for an income-producing purpose (citing Cal-Gas).

CRA accepted that but for the issue referred to above, s. 20.1 would have applied to deem the loans still to be used for an income-producing purpose following the seizure of the properties, assuming the seizure occurred after the effective date of s. 20.1.

26 March 2012 External T.I. 2010-0367351E5 F - Emprunt pour faire prêt sans intérêt à une fiducie

interest-free advance to trust used, in urn, for income-producing purpose

a trust which is the sole beneficiary of a second trust (Trust B) is entitled to an interest deduction on money borrowed by it to make an interest-free advance to Trust B, which will use the advanced funds to acquire income-producing assets.

7 October 2011 Roundtable, 2011-0412041C6 F - Accumulated Profits for 20(1)(c)

as retained earnings do not include a surplus resulting from a revaluation, an amount added to retained earnings as a result of fair value adjustments under section 1500 of the CICA Handbook (Part II, Private Enterprises) should not be included in accumulated profits.

2011 Ruling 2011-0411821R3 - Interest deductibility and loss carry backs

cross-border downstream loan to distribute cross-border PUC

a limited partnership ("BForLP") owns substantially all of the membership interests in a (presumably Netherlands) holding cooperative which owns all the shares of a non-resident corporation ("BForHoldco") which holds all of the shares of a taxable Canadian corporation ("BCo") which holds a majority of the voting common shares (Class B shares) of another taxable Canadian corporation ("Opco") with the balance of the common shares (Class A shares) and preferred shares being owned by a taxable Canadian corporation ("ACo") with which BCo deals at arm's length.

BForLP uses the proceeds of a daylight loan to make an interest-bearing loan (the "Sub Debt") to BCo, with BCo using the lent money to distribute paid-up capital (used by BCo for an income-producing purpose) to BForHoldco, and so on up the chain so that BForLP can fund the repayment of its daylight loan. BForHoldco then transfers its B shares to Opco in consideration for the issue of shares of a new class of common shares of Opco (with this "tuck-under" transaction not being ruled on), Aco effects a simultaneous s. 86 exchange of its shares in Opco (so as to preclude the tuck-under transaction giving rise to an acquisition of control of Opco by Aco), and BCo and Opco then amalgamate by way of a vertical short-form amalgamation.

Interest-deductibility ruling given re the interest accruing to the amalgamated corporation on the Sub Debt.

29 October 2010 Internal T.I. 2010-0357241I7 - Exchangeable Debenture

In response to a query as to the deductibility of interest on a note which was exchangeable into "Underlying Shares," CRA indicated that interest on the portions of the note whose proceeds were (i) put into a collateral account to pay interest on the note, (ii) lent to a trust of which the taxpayer was both a capital and income beneficiary, or (iii) used to pay legal fees incurred in issuing the note, was deductible.

5 June 2008 TI 2007 - 025221 [partial sale/partial disappearing source]

partial sale/partial disappearing source

In indicating that there would be partial loss of interest deductibility on money borrowed in order to acquire mutual fund units, where a portion of the mutual funds were sold with the proceeds used to pay interest on the loan for the year, CRA stated:

"The proceeds from the units disposed of have not been used to acquire a new source of income nor have they been used to earn income from an existing source of income, rather, they have been used for the purpose of paying interest, which, in our view, is a capital expenditure and not a current operating expense incurred for the purpose of earning income from the business or property."

14 May 2008 Internal T.I. 2008-0304841I7

interest not deductible after CCAA stay

"CanOpco" is a 100% subsidiary of "NRHoldco,” a US based corporation, which filed for protection under Chapter 11 of the U.S. Bankruptcy Code. On the same date, CanOpco filed for creditor protection under the CCAA. During the stay order period, CanOpco had accrued significant interest expense on inter-corporate loans. For purposes of 20(1)(c), did CanOpco have a legal obligation to pay interest during the stay order period? CRA responded negatively, stating:

[]I]n Re Philip's Manufacturing Ltd. (1992), 12 C.B.R. (3d) 133 (B.C.S.C.), add'l reasons in (1992), 91 D.L.R. (4th) 766 (B.C.S.C.) aff'd in (1992), 12 C.B.R. (3d) 149 (B.C.C.A.), it was held that, since the purpose of the stay of proceedings under the CCAA was to maintain the status quo, no interest was payable on claims during the period of the stay without a court order.

… CanOpco's legal obligation to pay interest expired on the day it obtained protection from its creditors under the CCAA. Beyond that day, the obligation to pay such interest could not exist because its creditors, by virtue of the stay proceedings, could not enforce payment. Therefore, as there is no legal obligation to pay interest during the stay order period, in our view, the debtor, i.e., CanOpco, cannot deduct any interest expense during that period pursuant to paragraph 20(1)(c)… .

2008 IFA Round Table, Q. 10.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 18.2 - Subsection 18.2(3) 0

15 November 2007 External T.I. 2007-0254941E5 - Interest Deductibility - Second Loan

Where a taxpayer borrows money in order to acquire shares of a corporation and then borrows under a second loan to pay the interest under the first loan, the interest on the second loan will be deductible if the interest on the first loan was deductible.

2007 Ruling 2007-0245281R3

assumed debt traceable to capital distribution

A corporation ("Bidco") assumes the third-party debt of an income fund (the "Fund") whose units it has acquired as consideration for the subscription for additional units in the Fund, and then had the Fund's assets (principally, limited partnership units of the subsidiary partnership) transferred to Bidco in consideration for a note of Bidco, with the Fund then distributing the note to Bidco in satisfaction of a capital distribution and capital gains distribution declared by the trustees of the Fund.

Interest deductibility ruling given respecting the interest on the debt so assumed by Bidco.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 40 - Subsection 40(3.3) capital loss on redemption of trust units following distribution of most of its assets including as capital gains distribution 106
Tax Topics - Income Tax Act - Section 53 - Subsection 53(2) - Paragraph 53(2)(h) - Subparagraph 53(2)(h)(i.1) no ACB reduction for capital gains distribution by unit trust to bidco 84
Tax Topics - Income Tax Act - 101-110 - Section 104 - Subsection 104(21) trustees making filings on behalf of terminated fund 46
Tax Topics - Income Tax Act - 101-110 - Section 104 - Subsection 104(6) realization and distribution of target MFT gain 99
Tax Topics - Income Tax Act - Section 80 - Subsection 80(1) 86
Tax Topics - Income Tax Act - Section 80 - Subsection 80(5) 86

Income Tax Technical News, No. 34, 27 April 2006 under Income Trusts and Interest Deductibility".

[W]here a corporation has borrowed to repurchase shares, the deductibility of the interest is related to the amount of the debt required to “fill the hole.” In the income trust conversion context, by inserting a holding corporation and having that corporation acquire the operating company shares, there is an acquisition of property for an income earning purpose and when the two corporations merge, a link is established between the acquisition of the operating company shares that disappear on the merger and the assets formerly held by that corporation that are now in the new operating corporation.

The CRA considers that paragraph 21 of IT-533 applies to the notes issued in the income trust conversion context. Thus, absent any issue concerning the reasonableness of the interest rate, in these and similar circumstances, the CRA permits the deduction of all interest paid or payable, without any restriction relating to the “fill the hole” concept

IT-533 "Interest Deductibility and Related Issues" 31 October 2003

Exceptions to the direct use test - borrowed money used by a corporation to redeem shares, return capital or pay dividends

23. Interest expense on borrowed money used to redeem shares or return capital can be an exception to the direct use test. In connection with this use, the purpose test will be met if the borrowed money replaces capital (contributed capital or accumulated profits) that was being used for purposes that would have qualified for interest deductibility had the capital been borrowed money (eligible purposes). Consistent with the concept of filling the hole, contributed capital generally means the funds provided by the shareholders to commence, or otherwise further, the carrying on of the business. While in most situations the legal or stated capital for corporate law purposes would be the best measurement of contributed capital for this purpose, other measurements may be more appropriate depending on the circumstances. In situations where some proportion of shares is being replaced with borrowed money, only the capital of those shares, computed on a pro-rata basis, would be considered to be replaced with the borrowed money. A corporation's deficit does not reduce contributed capital for purposes of this exception.

Similarly, with regard to the payment of dividends (including deemed dividends), borrowed money used to replace the accumulated profits of a corporation that have been retained and used for eligible purposes can be an exception to the direct use test. Accumulated profits would generally be the retained earnings of the corporation computed on an unconsolidated basis with investments accounted for on a cost basis. The accumulated profits of a corporation do not track any particular shareholdings. …

Exceptions to the direct use test - borrowed money used by a partnership to return capital to a partner

24. The concepts described in ¶ 23 are equally applicable where a partnership borrows money to return capital to a partner. In such a case, the "hole that can be filled" generally consists of the capital contributed by the partner to commence or further the carrying on of the business, plus any partnership income less any partnership losses allocated to the partner, and less any previous distributions to the partner. Generally, the balance in the partner's capital account would represent this amount.

Borrowing for investments including common shares

31. ...Normally, however, the CCRA considers interest costs in respect of funds borrowed to purchase common shares to be deductible on the basis that there is a reasonable expectation, at the time the shares are acquired, that the common shareholder will receive dividends

2005 Ruling 2005-013054 -

Interest deduction rulings given with respect to debt on which there is base interest, plus additional interest equal to the lesser of the taxable income of the debtor (computed before the interest deduction) minus $x, and the percentage which would bring the total interest rate up to the prevailing market rate of interest for comparable debt.

2005 CALU Roundtable Q. 5, 2005-0116661C6 -

Where a taxpayer borrows money to use in its business and in order to pay interest on this loan the taxpayer borrows money under a second loan, interest under the second loan will be deductible if the interest on the first loan was deductible.

2004 APFF Roundtable Q. 30, 2004-0086981C6 -

relevance of accounting methods to shares' capital

Respecting a question as to how CRA would view the capital of preferred shares that are redeemed with the proceeds of borrowed money, where the preferred shares were issued under an s. 85(1) rollover transaction and were deemed under s. 85(2.1) to have zero paid-up capital, CRA stated:

"In the situation described, the CRA would examine among other things, the accounting method used for the rollover transactions to determine whether the borrowed funds replenished the capital the borrower previously used for eligible purposes. This is a question of fact which can be resolved only after the facts surrounding a specific situation have been fully analyzed."

14 January 2005 Internal T.I. 2004-009814 -

assumption in consideration for debt forgiveness

The interest on debt previously owing by the taxpayer's shareholder that the taxpayer assumed in consideration for the forgiveness of a non-interesting bearing loan that had been owing by it to the shareholder and which had resulted from the transfer, in a prior year, of public shares from the shareholder to the taxpayer was non-deductible given that such assumed debt would not represent borrowed money and the forgiveness of the debt would not result in the acquisition of property.

17 December 2004 External T.I. 2004-008488 -

assumption in consideration for asset purchase

Respecting a question whether the assumption by a trust of another person's indebtedness (a loan payable by a corporation to "Finco") as part of the purchase price of an asset (a note payable by another trust), CRA noted that if a taxpayer has assumed another person's indebtedness as part of the purchase price of an asset acquired by the taxpayer, interest paid on the assumed debt generally is deductible under s. 20(1)(c)(ii).

2004 Ruling 2004-007680 -

//www.bci.ca/">www.bci.ca): Non-capital losses of BCI are transferred to its affiliate, Bell Canada, pursuant to transactions under which a subsidiary of Bell Canada ("Bell Subco") borrows up to $17 billion on a day-light loan and uses the borrowed money to subscribe for preferred shares of a newly-incorporated subsidiary of BCI ("BCI Subco"), BCI Subco lends the money on a non-interest bearing basis to BCI, BCI lends the same funds on an interest-bearing basis (1 basis point lower than the dividend rate on the preferred shares) to Bell Subco, which pays off the day-light loan. BCI is paid for the loan by the parent of Bell making a capital contribution to a second newly incorporated subsidiary of BCI, with that subsidiary then being wound-up into BCI.

Bell Subco interest deductibility ruling given.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 12 - Subsection 12(1) - Paragraph 12(1)(x) contributions of capital 186

2004 Ruling 2004-006195 -

A Canadian holding company ("MCo") for a foreign parent is no longer able to earn sufficient income to service its long-term debt, whereas its wholly-owned Canadian subsidiary ("NCo") has additional debt-servicing capacity. For foreign income tax reasons, MCo is precluded from a direct method of leveraging, namely, incorporating a wholly-owned subsidiary ("OCo"), and transferring its NCo shares to OCo for an interest bearing loan and share consideration and having NCo and OCo amalgamate.

Instead, MCo uses a bank borrowing to make an interest-bearing loan to OCo. OCo uses those proceeds to subscribe for common shares of NCo. NCo uses the proceeds to purchase for cancellation common shares of MCo. MCo uses the proceeds to repay the bank loan, and then MCo transfers its remaining common shares of NCo to OCo for treasury shares of OCo, with OCo and NCo then amalgamating.

Ruling that the interest on the loan made by MCo to OCo is deductible provided that the loan is used by the amalgamated corporation for the purpose of gaining or producing income.

7 May 2003 External T.I. 2003-018400 -

Given that the determination of accumulated profits must respect the legal relationships that exist, accumulated profits should be determined on a consolidated basis.

2003 Ruling 2003-003299 -

Dco incurs a promissory note in acquiring all the common shares of Eco with Eco then amalgamating with a subsidiary (Rco). Cco, the parent of Dco lends money under a demand promissory note (the "Promissory Note") to finance the repayment of the Promissory Note, and Dco and Rco amalgamate.

The interest on the Promissory Note payable by the amalgamated corporation will be deductible subject to the usual requirements.

19 December 2002 TI 2002- 014870

A non-resident partner is permitted to deduct interest expense on money borrowed to acquire an interest in a partnership that earns rental income from a property located in Canada if the partner has made an election under s. 216.

Paul Lynch and Roy Shultis, "Interest Deductibility: Where From, Where To, Where Now?", 2002 Conference Report, c. 11.

2001 Ruling 2001-009728 -

XCo (a Canadian corporation that for U.S. purposes is regarded as being a branch of its U.S.-resident parent ("NR Subco")) uses borrowed money to lend to a Canadian subsidiary ("Holdco") pursuant to a note (the "Holdco Note") the interest on which is payable in preferred shares of Holdco. NR Subco and Holdco enter into a subscription agreement in which it is agreed that NR Subco will subscribe for common shares of Holdco in order to enable Holdco to have sufficient funds to repay the principal of the Holdco Note. As security for the Holdco Note, Holdco issues a direction to NR Subco stipulating that NR Subco shall pay to XCo all amounts which become payable by NR Subco to Holdco under the subscription agreement. Holdco uses the proceeds from the Holdco Note to make a return of capital to XCo.

CCRA provides an opinion based on draft section 20.2.

4 January 2001 External T.I. 2000-005547 -

In the case of a share redemption,

"a corporation may borrow to the extent that the stated capital of those shares and the accumulated profits or retained earnings that are utilized to effect the redemption. ... A corporation may borrow to redeem shares issued on a transaction that was subject to an election under section 85 of the Act, to the extent of the stated or paid in capital of those shares as determined under the relevant corporate law plus the accumulated profits or retained earnings that are utilized to effect the redemption. In determining the amount that may be borrowed, neither the paid up capital of the shares nor the details of the section 85 election are relevant."

26 May 2003 External T.I. 2003-001242 -

On the sale of a home, the taxpayer is required by the lender to repay a loan that had financed mutual fund investments out of the sale proceeds, but the individual takes out a mortgage loan in an identical amount on the purchase of the second home (in addition to taking out a second mortgage loan). Interest on the first of the two new loans would be deductible provided the circumstances were similar to those in The Queen v. Grenier, 98 DTC 6439 (FCTD).

15 May 2003 External T.I. 2003-00626 -

extraction of appreciation

Where a taxpayer satisfied the purchase price for an income-producing property by assuming a debt owing by the vendor to a third party and, at a subsequent date when the property has appreciated in value from $100 to $120, transfers the property to a partnership in consideration for $20 in cash (which is used for a non-income producing purpose) and a $100 partnership interest, interest on the debt will continue to be deductible.

13 May 2003 External T.I. 2003-000082 -

Where an investor purchases a unit of a real estate investment trust for $10, receives a cash distribution of $0.80 and the REIT's income for tax purposes is $0.50, there will be considered to be a $0.30 return of capital to the unitholder, with the result that there will be a loss of interest deductibility if that $0.30 distribution of capital is not used by the unitholder for an income-producing purpose.

30 April 2003 External T.I. 2002-015604 -

Where a trust distributes shares of a Canadian corporation to a beneficiary on the condition that the beneficiary assume indebtedness owing by the trust, interest on the assumed indebtedness generally will be deductible under s. 20(1)(c)(ii).

25 March 2003 External T.I. 2002-017694 -

In the situation where dividends, whose ultimate aggregate amount eventually exceeded the corporation's accumulated profit, were funded out of a non-interest being loan from the parent, in order for interest to be deductible on a portion of the non-interest bearing loan that was converted to an interest-bearing loan it would be necessary to trace the interest-bearing loan to the original payment of dividends up to the amount of accumulated profits.

2003 Ruling 2002-017736 -

"It is no longer necessary for the dividend rate on the preferred shares to be greater than the interest rate on the loan (a so-called 'positive' spread), as had been customary in our previous loss utilization rulings. In this ruling, there is a 'negative' spread, that is, the dividend rate on the preferred shares is less than the interest rate on the loan. The dividend rate will, however, reflect an appropriate commercial rate considering the specific circumstances."

18 December 2002 Internal T.I. 2002-016174 -

Equity accounting may not be used to determine accumulated profits for the purpose of establishing interest deductibility on the payment of dividends or the return of capital.

16 July 2002 External T.I. 2002-014247 -

Where an individual borrows $10,000 at 4% interest and invests it in an income trust and receives, in the first year $1,400, of which $500 is income, the full amount of the interest on the borrowed money will not be deductible after the distribution (assuming the distribution is for an ineligible purpose) because a portion of the borrowed money will relate to a return of capital.

15 May 2002 External T.I. 2001-0103605 F -

validity of partner loan

Is the interest on a loan made to a partnership by a partner deductible under s. 20(1)(c)? CRA responsed (TaxInterpretations translation):

The question as to whether one of the partners of a partnership has made a loan or contribution to the partnership is a question of fact which cannot be resolved without an examination of all the relevant facts, and the applicable non-tax law (the Quebec Civil Code, common law, etc.). To the extent that there is a valid loan made by a partner of a partnership and the conditions contemplated in paragraph 20(1)(c) are satisfied, the interest on the loan is deductible in the calculation of the income of the partnership and does not constitute a distribution of profits of the partnership.

2002 Ruling 2002-016091 -

A foreign corporation ("ForeignCo") acquires a Canadian company ("Opco"): a wholly-owned newly-incorporated subsidiary of ForeignCo ("Holdco") uses borrowed money to acquire all the shares of Opco, Holdco transfers a portion of the common shares of Opco to ForeignCo as repayment of a portion of its indebtedness to ForeignCo, and ForeignCo then transfers those shares to another Canadian subsidiary ("Newco1").

In order to transfer interest expense from Holdco to the Opco business, Holdco transfers its common shares of Opco to a newly incorporated Canadian subsidiary ("Newco2") in consideration for a promissory note of Newco2 and for share consideration, and Newco2 and Opco then amalgamate.

A favourable interest deductibility ruling.

Income Tax Technical News, No. 18, 16 June 2000

Discussion of the extension of the "ultimate purpose test" in Byram, 99 DTC 5117 (FCA) to s. 20(1)(c).

2001 Ruling 2001-010887 -

After Acquisitionco acquires Target, Acquisitionco transfers all the shares of Target to a newly incorporated sub ("Newco") in consideration for common shares and a promissory note of Newco. Newco and Target amalgamate. To the extent the amount of interest on the promissory note owing by the amalgamated corporation is reasonable in the circumstances, Amalco will be entitled to an interest deduction pursuant to s. 20(1)(c)(ii).

31 May 2001 Internal T.I. 2000-006233 -

An agreement provided for the immediate receipt of a cash payment by the purchaser (a trust) from the vendor and obliged the vendor (a company in the resource sector) to deliver an agreed quantity of production at some time in the future. In finding that the vendor was not entitled to a deduction under s. 20(1)(c) in respect of this arrangement, the Agency stated:

"The relationship here is that of a seller and a buyer and the terms of the agreement do not create a lender-borrower relationship between [the Vendor] and the Trust. [The Vendor] does not have any obligation to repay the amount of the prepayment; its sole obligation is to deliver the [production] at the specified times."

In the Summary, it stated:

"Jurisprudence does not appear to lend support to the notion of bifurcating the agreements into two components, namely a forward sale and a loan."

29 January 2001 External T.I. 2000-006318 -

In response to a question on the deductibility of interest on borrowed money used for the purpose of investing in common shares of a technology company, the Agency indicated that "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."

4 January 2001 External T.I. 2000-005791 -

"Where there has been an accounting write-down in assets and a corresponding shareholder's deficit for accounting purposes but there is no adjustment to the stated capital of the shares under corporate law, it remains our view that interest may be deductible under paragraph 20(1)(c) on money borrowed to reduce the stated capital of the shares."

4 January 2001 External T.I. 2000-005547 -

"Accumulated profits or retained earnings, for the purpose of determining eligible borrowing, do not include appraisal surpluses or profits resulting from non-arm's length transactions that were carried out on a non-taxable or tax-deferred basis ... . As for a share redemption, a corporation may borrow to the extent of the stated capital of those shares and the accumulated profits or retained earnings that are utilized to effect the redemption. Accumulated profits or retained earnings need not be allocated proportionately among shareholders. A corporation may borrow to redeem shares issued on a transaction that was subject to an election under section 85 of the Act, to the extent of the stated or paid in capital of those shares as determined under the relevant corporate law plus the accumulated profits or retained earnings that are utilized to effect the redemption."

2000 TEI Roundtable Q. 18, 2000-0056275 -

The finding in the CRB Logging case that the closed nature of the income flow made it virtually impossible for CRB to receive dividends that did not originate from its own business activities represents the distinction between that case and those situations where Rulings has ruled favourably.

29 November 2000 Internal T.I. 2000-005136 -

Prejudgment and post judgment interest that was paid by a corporation in respect of the lapse of time between the departure of a shareholder and the final redemption of its shares would not be deductible under s. 20(1)(c) as there would be no property acquired for the purpose of gaining or producing income and the interest would not have accrued on borrowed money used for the purpose of earning income before the shares were redeemed. However, interest expense accrued on the portion of the bank loan that was used to pay the redemption amount of the shares would be deductible under s. 20(1)(c)(i) to the extent that the funds were used to return capital on the shares (there being no accumulated profits).

24 October 2000 Internal T.I. 2000-004817 -

assumption to redeem prefs

Where a corporation redeems its preferred shares and, as consideration, assumes a bank loan that the shareholder had previously incurred to purchase business assets which subsequently had been transferred to the corporation, the interest on the assumed debt will be non-deductible notwithstanding that if the corporation had assumed the debt upon its acquisition of those business assets, the interest would have been deductible under s. 20(1)(c)(ii).

29 March 2000 External T.I. 2000-000831 -

Where a target corporation borrowed money from a bank in order to make an interest-free loan to a holding company for management that would be using the funds to capitalize a subsidiary that would purchase the shares of the other shareholders of the target, the interest on the bank loan would be non-deductible: "The closed nature of the income flow makes it virtually impossible for Targetco to receive dividends that will not originate from its own business activities. Hence, Targetco cannot have a reasonable expectation that the borrowing from the bank will yield income in excess of the interest expense."

22 March 2000 External T.I. 2000-000270 -

Interest on money borrowed to make an interest-free loan to a subsidiary would not be deductible because the subsidiary was not resident in Canada.

23 February 2000 External T.I. 2000-000020 -

"In a situation where a taxpayer purchases a property from another taxpayer and assumes that taxpayer's mortgage liability in respect of the property, it is our view that the interest on the mortgage would be deductible by the taxpayer under subparagraph 20(1)(c)(ii) (interest on an amount payable for property acquired) and there would be no need to rely upon subsection 20(3) of the Act."

1999 Ruling 993171 [indirect then direct use]

indirect then direct use

Interest on debts used by a partnership to acquire fixed assets would still be deductible by the partnership after a transfer of those assets to a Newco, and after a reacquisition of those assets upon a winding-up of Newco.

1999 APFF Round Table, Q. 2 (No. 9M19190)

Where a Canadian public corporation borrows money in order to acquire units of a corporation that is an LLC, the interest will be deductible provided the units have the same features as common shares. Where they have the same features as a preferred share, the amount of interest not exceeding the dividends received will be deductible.

5 October 1999 T.I. 992477

Interest would not be deductible on a debenture with a mandatory conversion feature that permitted the borrower to repay holders with less than the amount advanced (e.g., by issuing shares with a lower fair market value). In such a situation, there was no satisfaction of the requirement, at law, that in order for a debt to represent borrowed money, the "lender" must be able, at some given time, to enforce repayment of the amount advanced, either by receiving the cash itself or property having an equal value.

16 September 1999 T.I. 991671

A corporation (the "Target") borrows money to lend to an unrelated corporation which uses those funds to purchase shares of the Target from a party to which the purchaser is unrelated. Target and the purchaser then amalgamate. In indicating that interest on the borrowing by the Target is deductible by the amalgamated corporation, RC noted that the net result of these transactions is identical to the situation in which the purchaser corporation, rather the Target, had borrowed the funds from the initial lender and used those funds to acquire the subject shares, with there being a subsequent amalgamation.

27 January 1999 Memorandum 983074

deductibility on borrowing not in excess of repatriated accounting capital

RC's policy that interest is deductible to the extent that the borrowing is not in excess of the paid-up capital reduction which the borrowing funded is consistent with the Trans-Prairie decision. RC further noted that in applying this policy:

[T]he reference to "paid-up capital" therein was meant to refer to the accounting concept of "capital" except in circumstances in which the capital has been increased in non-arm's length transactions such as may occur in an amalgamation of related corporations. In such cases in which there is an increase to the capital because of a non-arm's length transaction (other than a direct subscription for shares or capital contribution), the concept of capital for the purposes of measuring a the maximum borrowing permissable should be limited to the corporate capital as would be determined in the absence of such an increase.

14 October 1998 T.I. 973247

Where a corporate taxpayer borrows $10 million from a bank at 6%, and uses the borrowed funds to buy a business asset which, later, is sold giving rise to after-tax proceeds of $20 million which are invested in GICs paying interest at 4%, interest on the borrowed money will cease to be deductible at that point.

May 1998 Advanced Life Underwriting Round Table, Q. 4, No. 9807000

"The fact that paragraph 149(1)(q.1) exempts an RCA from being taxed under Part I of the Act on its taxable income does not, in and by itself, result in the income earned by the RCA being classified as exempt income for purposes of paragraph 20(1)(c) of the Act ... . Therefore, where an RCA incurs interest expenses in respect of debts incurred to earn investment income, the interest expenses would be deductible in computing the RCA's income for the purposes of computing its refundable taxes ... ."

1998 APFF Congress, Q. 19

A corporation X wishes to buy back the shares of one of its shareholders (corporation Y), and corporation B wishes to acquires shares of corporation X. Corporation B incorporates a wholly-owned subsidiary (corporation C) which uses borrowed money to invest in common shares of corporation X which then buys back the shares held by corporation Y. Corporations X and C then merge.

The interest on the borrowing would not be deductible. IT-315 applies "to cases where a person simultaneously acquires control and all or almost all of the shares of a target corporation through a loan whose interest would be deductible". Here, the loan was essentially made to buy back shares of corporation X and the purpose of the sequence of the transactions was to circumvent the rules set out in Interpretation Bulletin IT-80.

1998 Ruling 3-973243 -

Consideration of the reasonableness of an interest rate (8.7%) before giving favourable rulings on an arrangement respecting the deductibility of interest on money borrowed in order to redeem shares that had permitted the utilization of losses within a corporate group.

8 December 1997 T.I. 973056

The position in Question 5 of the 1996 Corporate Management Tax Conference Round Table would also extend to a public corporation.

16 July 1997 T.I. 971876

"Interest on money borrowed by a corporation to repay capital on the redemption, acquisition or cancellation of a share is generally deductible ... provided that the borrowed funds do not exceed the aggregate of the capital of the shares to be redeemed and the accumulated profits determined immediately before to the extent that the capital and accumulated profit was used by the corporation for a qualifying purpose. ... [T]he term 'capital' and 'accumulated profits' will refer to the accounting concepts of those terms where assets have been acquired in an arm's length transaction."

14 July 1997 T.I. 971602

Because interest paid in respect of a partnership interest is not deductible at the partnership level, interest payable by a non-resident corporation on money borrowed from another non-resident corporation to finance the acquisition of a Canadian partnership interest would not be deductible in Canada.

1997 Tax Executives Institute Round Table, Q. VIII, No. 9729670

In the Barbican situation (where interest is not deductible on an accrual basis because it is contingent in amount), the interest also would not be deductible under s. 20(1)(c) in the subsequent year in which it is paid, because in that year the amount is not "payable in respect of the year".

13 November 1996 T.I. 50963639 (C.T.O. "RESP Interest on Money Borrowed to Contribute")

When a contributor has an unrestricted right to receive all educational assistance payments available under the terms of an RESP, the contributor may deduct interest accrued each year on money previously borrowed in order to make a contribution to the RESP.

29 October 1996 External T.I. 5-962632 -

Where a corporation has issued an option giving the holder the right to acquire interest-bearing bonds of the issuer at a future date for an exercise price equal to the face amount of the bonds, with the bonds bearing interest at higher than the market rate at the time the options are issued, then following exercise of the option RC will examine whether "the excess of the interest rate over the market rate is compensation for the premium paid on the acquisition of the option and, consequently, not deductible pursuant to paragraph 20(1)(c)".

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 12 - Subsection 12(1) - Paragraph 12(1)(x) option premium 30

8 October 1996 Memorandum 962852 (C.T.O. "Interest Deductibility")

Non-arm's length transactions that had the effect of converting equity into debt were required to comply with RC's position on accumulated profits and return of paid-up capital in order to produce an interest deduction.

5 January 1996 Memorandum 952397 (C.T.O. "Gross-Up Payments")

Where a gross-up on interest paid to a non-resident meets the legal definition of interest, it will be deductible by the taxpayer under s. 20(1)(c) assuming the other conditions of that paragraph are met. "Where the taxpayer is engaged in the business of lending money and the financing is on income account the gross-up will be deductible as an ordinary business expense under section 9 of the Act."

1996 Ruling 963802

An interest deduction was available on a loan received in order to retire existing corporate indebtedness where the obligation to pay interest was deferred until there was sufficient income to pay the interest and provision was made for making an s. 78 election in the event that the interest remained unpaid at the end of the second subsequent taxation year. "Although the interest rate is based on a formula which is based upon profits for prior years, the rate is prospective in nature, and is payable in respect of the year whether or not there are profits and is referable to the principal amount. This is not a participating loan."

1996 Corporate Management Tax Conference Round Table, Q. 7

assumption of excess debt

Until RC completes its review of the subject, interest on excess debt assumed by a transferee corporation in an s. 85(1) rollover transaction will be deductible provided the assets were acquired by it for the purpose of producing income and the interest on the assumed debt was deductible by the transferor under s. 20(1)(c). "However, if any of the assumed debt is incurred by the transferor as part of the same series of transactions, the Department would have to review all the surrounding circumstances to determine whether the interest would be deductible to the transferee".

1996 Corporate Management Tax Conference Round Table, Q. 5

Interest on a promissory note owing by a corporation to its shareholders will be deductible to the same extent that interest would have been deductible by the corporation on money borrowed from an arm's length lender that was used by the corporation to redeem its shares (and would not be subject to GAAR) where:

  1. the shareholders borrow funds, on-lend the funds to the corporation for an interest bearing note, and the corporation uses the funds to redeem its shares, with the shareholders then retiring their loan; or
  2. the corporation borrows from its bank, redeems the shares, the shareholders loan the funds back to the corporation for an interest bearing-note, and the corporation pays off the bank loan.

1996 Corporate Management Tax Conference Round Table, Q. 1

Affirmation of administrative positions set out in former IT-80.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 20.2 - Subsection 20.2(1) 54

1996 Tax Ruling 960812 (C.T.O. "Loss Consolidation")

Interest on a loan from a subsidiary to a parent that was funded by a common share subscription by the parent, will be deductible to the parent provided the usual tests in s. 20(1)(c) are satisfied.

28 July 1995 T.I. 951955 (C.T.O. "IT-315")

"The policy expressed in IT-315 is applicable not only to interest on funds borrowed by a taxpayer to finance a share acquisition ... but also to interest on the unpaid portion of the purchase price of the shares which is deductible under subparagraph 20(1)(c)(ii)."

17 July 1995 T.I. 942971 (C.T.O. "Disappearing Source Rules")

"Where money is borrowed to permit withdrawals by the partner, the interest on such loans would not be deductible since the borrowed money is not used to replace an amount that is being used by the partnershp to earn income from a business."

May 1995 Tax Executive Institute Round Table, Q. 16 (C.T.O. "Interest Deductibility - Preferred Shares")

Where the interest on a loan is received by a corporation to acquire preferred shares exceeds the dividends return on the preferred shares, the interest expense in a given year will be restricted to the dividends actually received in that year.

2 February 1995 Memorandum 943055 (C.T.O. "Interest on Money Borrowed to Pay Interest")

Interest on money borrowed to pay interest is deductible "provided the reason for the predicament in which the individual finds himself is bona fide and not part of a series of transactions that gives the individual an undue tax advantage" and provided "the original borrowing was used either in the day to day business activities of the taxpayer or was used to acquire a property".

Income Tax Regulation News, Release No. 3, 30 January, 1995 under "Interest-Bearing Note issued in Consideration for the Redemption or Repurchase of Shares"

Interest payable on a promissory note issued as consideration for the redemption or purchase for cancellation of a corporation's capital stock is not deductible under s. 20(1)(c) (nor would a deduction be available under draft s. 20.2(1)).

Income Tax Regulation News, Release No. 3, 30 January, 1995 under "Use of a Partner's Assets by a Partnership"

Where a property is acquired by a partner for the purpose of making it available to the partnership to be used in carrying on the business of the partnership, that property will be considered to have been acquired by the partner for the purpose of earning income if the partnership business is carried on with a view to profit, notwithstanding that the partner does not charge rent to the partnership.

9 September 1994 Memorandum 942195 (C.T.O. "Deductibility of Deep Discounts as Interest and IT-114")

A shallow original-issue discount on a debenture would be subject to the application of ss.18(1)(f) and 20(1)(f), and would not be viewed as interest. If factually a discount on a debenture "is an interest expense for the borrower, the effective rate of interest on the issue price can be determined on a compound interest basis. This rate times the issue price will be allowed annually as simple interest under paragraph 20(1)(c). The balance of the deep discount is compound interest and is allowable under paragraph 20(1)(d) only when paid".

6 September 1994 T.I. 941995 (C.T.O. "Interest Deductibility")

In response to a query as to whether interest would be deductible on borrowed money that is used to acquire a mutual fund investment which generates almost all capital gains, rather than interest or dividend income, RC stated that "interest expense which relates to an investment which yields capital gains, and is not expected to produce net income, would not be deductible".

3 June 1994 Internal T.I. 7-940542 -

Consideration of interest deductibility in a situation where a loan is used to purchase preferred shares which are exchanged for common shares of a related company three months after their acquisition.

Revenue Canada Round Table TEI, 16 May 1994, Q. 14 9410430

assumption of debt with above-market interest

Where a debt obligation of Co. A owing to an arm's length creditor ("Co. B") bearing an above-market rate of interest is irrevocably assumed by Co. C in consideration for a cash payment representing the fair market value of the obligation, including a "reverse premium" representing the discounted value of the excess interest differential, Co. C will not be able to deduct any of the interest on the assumed debt because the assumption was not part of the purchase price for an asset acquired by it. The reverse premium paid by Co. A will not be deductible by it as it is on account of capital and does not qualify as interest.

1994 A.P.F.F. Round Table, Q. 32

Where a corporation redeems its shares in consideration for issuing an interest-bearing note, interest on the note will not be deductible under either s. 20(1)(c)(i) or (ii).

1993 A.P.F.F. Round Table, Q.3

Where an individual has borrowed $100,000 to acquire common shares for that amount and the shares then appreciate in value to $500,000, there will be a denial of the deduction of 1/5 of the interest on the loan following any of the following three transactions (assuming the funds generated are used for personal purposes): The individual transfers the shares to a holding company in consideration for $100,000 in cash and common shares worth $400,000; the holding company issues common shares worth $500,000 and there is a subsequent distribution of $100,000 of paid-up capital; the holding company following the issuance of $500,000 of common shares pays a dividend of $100,000.

93 C.R. - Q. 8 (File 932812)

Interest payable on funds borrowed to purchase newly-issued preferred shares that provide for dividends on the board's discretion and that are only entitled to a return of the subscription price on dissolution of the corporation will, in general, be considered by RC not to have been acquired for the purpose of earning income, with the result that the interest on funds borrowed to acquire the shares will only be deductible to the extent of the dividend income.

29 July 1993 Memorandum 9320007

"The deduction of interest should not be denied to a Canadian corporation that borrows funds to invest in a subsidiary, by way of contributed surplus provided the funds are to be used in a business to earn income and it is reasonable to expect that dividends will be earned by the Canadian corporation in the foreseeable future."

28 June 1993 T.I. (Tax Window, No. 32, p. 19, ¶2619)

Where there is a repayment of a portion of debt which has partly been used for an income-producing purpose and partly to acquire non-income producing assets, the repayment will reduce both the amount of borrowed money used for an income-producing purpose and that used for a non-income producing purpose.

17 June 1993 T.I. (Tax Window, No. 32, p. 18, ¶2616)

Interest expense will continue to be deductible where an individual has borrowed to acquire common shares and there is a reduction in the paid-up capital of those shares, irrespective of the use to which he puts the funds received on the paid-up capital reduction.

December 1992 B.C. Tax Executives Institute Round Table, Q. 1, 923039 (C.T.O. "Options"), (October 1993 Access Letter, p.475)

Where a corporation grants investors an option to acquire a debenture with terms identical to those of an existing callable debenture, RC will consider applying s. 245(2) given that the economic effect of the arrangement is to convert a capital receipt (proceeds of sale of the option) into an income deduction in respect of the interest payments.

17 December 1992 Memorandum (Tax Window, No. 27, p. 10, ¶2357)

Where preferred shares acquired in an arm's length situation can be converted into common shares on a free and unrestricted basis, any related interest expense normally will be fully deductible provided that interest would have been deductible on a borrowing to acquire the common shares. However, where the convertible shares are owned by a shareholder who does not deal at arm's length with the corporation, the deductibility of interest can only be determined from the facts of the specific case.

October 1992 Central Region Rulings Directorate Tax Seminar, Q. P (May 1993 Access Letter, p. 233)

Re: deductibility under s. 20(1)(c)(iv) of interest under a reverse mortgage arrangement.

1992 Tax Executives Institute Round Table, Q.14 (C.T.O. "Premiums on Debt Obligations")

"Paragraph 29 of IT-114 was drafted to address a situation where interest rates had fluctuated between the date the financing contract was initiated and the date the debt instrument was sold to investors. We are now finding borrowers and lenders dealing on a one to one basis and negotiating a premium in exchange for higher interest rate. This may result in an interest expense which is not reasonable for purposes of paragraph 20(1)(c)".

92 C.R. - Q.8

Interest will not be deductible on borrowed money used to acquire common share purchase warrants where the purchaser is not in the business of buying and selling warrants.

92 C.R. - Q.3

Interest on indebtedness of another person assumed by a taxpayer will be deductible to the extent provided in s. 20(1)(c)(ii) where the indebtedness was assumed as part of the consideration for an asset acquired by the taxpayer.

4 August 1992 External T.I. 5-911257 -

Purchasers of condominiums are able to deduct the interest on money borrowed by them to fund interest-bearing deposits made with the developer pending the final condominium registration notwithstanding that they will acquire the condominiums for personal use, provided that the interest paid on the deposits by the developer exceeds the interest payable by the purchasers.

26 March 1992 External T.I. 5-913338 -

Where a holding company assumes all of the debt associated with a property acquired by it from its subsidiary, interest on that debt will be deductible provided the property is used by the holding company for the purpose of earning income, even though for purposes of an s. 85(1) election, a substantial portion of that debt was assumed as consideration for a promissory note of the subsidiary rather than as payment for the transferred property.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 85 - Subsection 85(1) 74

27 March 1992 External T.I. 5-920466 -

Discussion of the requirements for the effect of transfer of losses from a subsidiary to its parent including a requirement that the transactions be commercially reasonable when compared to the amount of money which each corporation could reasonably expect to borrow from an arm's length lender for use in its business.

1992 A.P.F.F. Annual Conference, Q. 21 (January - February 1993 Access Letter, p. 58)

RC will consider the interest on mortgage debt assumed by a transferee corporation to be deductible, provided that the acquired property is used in order to produce income, notwithstanding the occurrence of transactions to make the transfer occur on a roll-over basis under s. 85(1)(b) and the existence of excess debt.

92 C.M.TC - Q.9

RC has not adopted the position that interest is non-deductible simply because the lender has limited recourse.

92 C.M.TC - Q.3

Interest will be deductible on indebtedness which has been assumed by a purchaser in satisfaction of the purchase price, or that is assumed by the purchaser in satisfaction of an amount payable by it to the vendor in consideration for the acquired property.

92 C.M.TC - Q.1

RC is maintaining its policy respecting when participation payments are deductible as interest.

14 April 1992 Memorandum (Tax Window, No. 18, p. 12, ¶1845)

Adjustments to the principal amount of a loan based on changes in the consumer price index are not interest and, therefore, are not deductible.

27 March 1992 T.I. (Tax Window, No. 18, p. 12, ¶1838)

Where a corporation borrows money from a related corporation at a commercial rate of interest to acquire cumulative preferred shares of another corporation in the group with a dividend rate above the borrowing rate, the interest expense of the borrowing corporation will be deductible. The general anti-avoidance rule would not apply.

26 March 1992 T.I. (Tax Window, No. 18, p. 2, ¶1831)

Where, in connection with the transfer by Opco to its parent, Holdco, of property subject to debt in excess of the property's ACB, Holdco first assumes the excess debt in consideration for a promissory note of Opco, and then Holdco surrenders that promissory note to Opco in consideration for the redemption of preference shares issued by Holdco to Opco on the transfer, the interest on the assumed debt will be deductible provided that interest on that debt was deductible by Opco and the property is used by Holdco to earn income.

91 C.R. - Q.18

Where a corporation uses the proceeds of a share issuance in its business for an income-producing purpose and then, in a subsequent year, reduces the paid-up capital of those shares on a distribution of interest-bearing notes to the shareholders, the interest on those notes will not be deductible.

15 October 1991 T.I. (Tax Window, No. 11, p. 18, ¶1526)

The maximum amount of interest that a cash-basis farmer may deduct under s. 20(1)(c) is the interest paid in the year which is not refundable.

September 1991 Memorandum (Tax Window, No. 9, p. 19, ¶1467)

S.20(1)(c) does not permit a shareholder to deduct interest on borrowed money used to make a contribution of capital to the corporation.

26 July 1991 T.I. (Tax Window, No. 7, p. 2, ¶1376)

Whether the interest rate on commercial paper, which is issued at a premium, is reasonable is a question of fact.

10 July 1991 Decision Summary (Tax Window, No. 5, p. 2, ¶1345)

If A Co. were to borrow money from B Co. and B Co. were to assign the loan to a bank, A Co. will continue to be entitled to deduct the interest provided there is no novation.

Where Purchaserco borrows money from a bank to acquire all the outstanding shares of Opco, following which its shareholders exchange their shares for shares of Opco, Purchaserco is wound up, and the debt of Purchaserco is assumed by Opco, Opco will not be entitled to deduct the interest on the assumed debt.

Where on an s. 85(1) roll of real estate with excess mortgage debt, the transferor gives the transferee a promissory note in the amount of the excess debt, the interest on the assumed mortgage debt will be deductible.

25 April 1991 T.I. (Tax Window, No. 2, p. 5, ¶1213)

Exclusion from accumulated profits of accounting gain realized by Canadian corporation on the transfer of shares of foreign affiliate to a related corporation.

24 April 1991 T.I. (Tax Window, No. 2, p. 4, ¶1213)

The determination of the amount of capital returned to a shareholder on the redemption of shares issued on a rollover will not be affected by the stated capital of the shares.

11 March 1991 T.I. (Tax Window, No. 1, p. 5, ¶1155)

Where a partnership has agreed to pay out the capital account of a partner which has withdrawn over a period of time plus interest thereon, the interest will not be payable on "borrowed money" or on an amount payable for property and, accordingly, will not be deductible.

1 February 1991 T.I. (Tax Window, Prelim. No. 3, p. 27, ¶1115)

An individual, who holds the preference shares of a holding company whose common shares are held by his children, borrows money at 13% and lends it directly to Opco (whose shares are held by Holdco) at no interest, he will be entitled to deduct the interest expense if he meets all the conditions of paragraph 7 of IT-445.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 15 - Subsection 15(1) 54

16 November 1990 T.I. (Tax Window, Prelim. No. 2, p. 21, ¶1076)

Where Corporation A borrows money to acquire the shares of Corporation B and the two corporations are amalgamated or Corporation B is wound-up into Corporation A, interest on the money borrowed by Corporation A to acquire the shares of Corporation B will be deductible irrespective of the level of accumulated profits of Corporation B.

13 September 1990 Deputy Minister's Office Letter (Tax Window, Prelim. No. 1, p. 19, ¶1007)

Where under a reverse mortgage plan the homeowner borrows money on the security of his home on terms which defer the obligation to pay interest on principal until the homeowner dies or the home is sold, and the proceeds of the loan are used to purchase annuities, the income portion of such annuities will be taxable and the interest deductible.

90 C.R. - Q11

Description of circumstances in which interest deduction will be available where a parent company incurs interest expense on borrowed funds used to acquire preferred shares of a subsidiary having a low or non-cumulative dividend entitlement.

90 C.R. - Q12

The simple interest will be deductible on a paid or payable basis under s. 20(1)(c) on a five-year debenture whose principal and accrued but unpaid interest are convertible into common shares at the option of the holder at an exchange ratio established at the date of issue of the debenture. The compound interest will be deductible under s. 20(1)(d) when paid.

28 June 1990 T.I. (November 1990 Access Letter, ¶1511)

Interest was not deductible where the source of income - namely, preferred shares-disappeared upon redemption.

15 June 1990 T.I. 900645

"A shareholder who transfers borrowed funds to a Canadian or foreign corporation as contributed surplus would not directly acquire any property. Therefore, in accordance with the above-quoted comments [in IT-445], the interest expense would not be deductible."

15 June 1990 T.I. (November 1990 Access Letter, ¶1510)

Interest on money borrowed by a corporate shareholder to make a contribution of capital to a wholly-owned subsidiary will not be deductible.

30 April 1990 T.I. 91042-4 [debt not assumed for income-producing property]

debt not assumed for income-producing property

A B.C. corporation ("A") borrows money in order to acquire all the common shares of Opco, the shareholders of A transfer their shares of A to Opco in consideration for shares of Opco, and A is wound-up into Opco. When Opco assumes the debt of A on the winding-up of A, it cannot be said that Opco has borrowed money used for the purpose of earning income from a business or property. In addition, the interest expense incurred by Opco because of the winding-up of A cannot be said to relate to an amount payable for property acquired for an income-producing purpose - Opco has only acquired its own shares as the result of the winding-up of A. RCT stated:

Interest on assumed indebtedness would not be deductible where A Co. assumes a debt of B Co., including indebtedness attributable to borrowed money of B Co., in payment of money previously borrowed by A Co. from B Co.

26 February 1990 T.I. 5-9484 [non-deductible where debt assumed in repayment of money previously borrowed]

non-deductible where debt assumed in repayment of money previously borrowed

In a hypothetical situation, a debt of a company (B Co.) to an arm's length person would be assumed by a related company (A Co.) in repayment of money previously borrowed by A Co. from B Co. It is our opinion, based on the comments of Mr. Justice Estey in M.N.R. v. T.E. McCool Ltd., 49 DTC 700(SCC), that the assumed debt would not be "borrowed money" for the purposes of subsection 20(3) and subparagraph 20(1)(c)(i) of the Act. There is no other provision of the Act nor does the Department have an administrative policy which would allow A Co. to deduct interest with respect to the assumed debt.

8 December 1989 T.I. (May 1990 Access Letter, ¶1210)

The reference in subparagraph 7(a) of IT-445 to a requirement that business or property income be subject to Part I tax includes a situation where dividends are included in income under Part I but are deductible under s. 112(1) in computing taxable income.

1990 Answers of Scarborough District Office (May 1990 Access Letter, ¶1200, Q. 8)

Where borrowed funds have been used for an ineligible purpose, RC will analyze the information derived from the taxpayer's books and records. Where there is no clear relationship between a taxpayer's sources of funds and their use, some form of pro-ration may be necessary.

8 November 89 Decision Summary (April 90 Access Letter, ¶1170)

A discussion of the guidelines employed with respect to arrangements whereby losses are shifted within a corporate group through the issuance of interest-bearing notes in exchange for dividend-bearing preference shares.

19 September 89 T.I. (February 1990 Access Letter, ¶1100)

A partner's capital is generally his equity account (determined in accordance with GAAP but excluding appraisal surpluses) immediately before the distribution is made.

5 September 89 T.I. (February 1990 Access Letter, ¶1101)

A payment of interest by a Quebec cooperative on a preferred share is not payment of interest on borrowed money, and therefore is not deductible.

89 C.M.T.C - "Participating Loans"

general discussion of participating loans. Where a borrower pays an above-market rate of interest corresponding with a strong likelihood that the amount repayable on maturity will be less than the amount originally borrowed, RC is not satisfied that the amounts stipulated to be interest are in fact interest.

89 C.M.TC - Q.1

interest on money borrowed by a partnership to distribute appraisal surplus is non-deductible regardless of the use made by the partner of the distributed money.

88 CPTJ - Q.3

A taxpayer is precluded from deducting interest charges on PIP/CDIP overpayments, the rationale being that interest exigible under such circumstances would not be on "borrowed money".

88 C.R. - "Finance and Leasing" - "Leasing"

The providing of a lease does not constitute the lending of money by the lessor to the lessee.

88 C.R. - "Finance and Leasing" - "Interest" - "Purchase of Common Shares"

Interest on money borrowed in order to purchase common shares normally is considered to be deductible on the basis that the potential return to the common shareholder may exceed his borrowing cost.

88 C.R. - "Finance and Leasing" - "Interest" - "Deep Discount and Zero Coupon Bonds"

A true discount does not meet the requirement for day-to-day accrual (cf. a discount which by reference to all the supporting documents is truly interest).

88 C.R. - "Finance and Leasing" - "Interest" - Leveraged Buy-Out"

Where Targetco borrows to pay a dividend to allow Purchaseco to retire its acquisition debt, then the interest is only deductible to the extent that the borrowings do not exceed the accumulated profits of Targetco. The accumulated profits test generally is not applied where Targetco is amalgamated with Purchaseco.

88 C.R. - "Finance and Leasing" - "Interest" - "Appraisal Surplus"

Accumulated profits does not give effect to any non-arm's length transactions which transform appraisal surplus into accumulated profits.

88 C.R. - "Finance and Leasing" - "Interest" - "Decline in Value of Assets"

A decline in the value of assets will not preclude the deductibility of interest, provided the source of income (i.e., the relevant business, or the particular property) continues.

88 C.R. - "Finance and Leasing" - "Interest" - "Loans to Non-Arm's Length Persons"

The essence of a transaction, and not merely the formality, is relevant in determining the use of borrowed money.

88 C.R. - "Finance and Leasing" - "Interest" - "Bonus on Early Redemption of Debt"

Usually an amount paid on the early redemption of a debenture is not regarded as interest as it does not accrue day to day.

88 C.R. - "Finance and Leasing" - "Interest" - "Amounts Paid on Redemption of Bonds or Purchase of Bonds in the Open Market"

Where an issuer purchases a bond on the open market (as opposed to redeeming it) the accrued interest will never be deductible by it.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 214 - Subsection 214(7) 37

88 C.R. - "Finance and Leasing" - "Interest" - "Participating Loans"

Where participating payments are limited to a percentage of the principal amount reflecting commercial interest rates, then the amounts can be considered to be referable to the principal amount.

Hiltz, "Tax Treatment of Interest: Bronfman Trust and the June 2, 1987 Release", 1987 Corporate Management Tax Conference Report, C. 10.

87 C.R. - Q.52

Deductibility of participating interest payments.

87 C.R. - Q.54

Discussion of three disappearing source issues.

85 C.R. - Q.22

Interest on money borrowed for the purpose of purchasing property will cease to be deductible if the property subsequently becomes worthless.

84 C.R. - Q.18

Where one income source is disposed of and the proceeds are used to acquire another, the interest will continue to be deductible to the extent that the borrowing is reflected in the cost of the new income source.

84 C.R. - Q.41

On an SRTC "quick flip", assuming $100 was borrowed and $55 received on redemption and used for the purpose of earning income from business or property, interest only on the $55 will be deductible.

84 C.R. - Q.59

Interest on money borrowed to acquire shares on which the taxpayer has the option of receiving cash or stock dividends, is deductible.

84 C.R. - Q. 60

Where a Canadian corporation with debt denominated in currency X on which interest is deductible borrows funds in currency Y under a currency swap, the interest paid on the currency Y debt is deductible under s. 20(1)(c).

81 C.R. - Q.39

Interest that exceeds the grossed-up amount of dividends on preference shares as a result of escalating interest rates will nonetheless be deductible provided that the increase in the borrowing costs was not reasonably foreseeable at the time that the shares were acquired with the borrowed money. Normally, RC considers interest costs in respect of funds borrowed to purchase common shares to be deductible.

80 C.R. - Q.3

Discussion of the circumstances in which RC will permit a deduction for the full interest expense incurred in order to acquire preferred shares bearing a lower dividend rate.

80 C.R. - Q.7

If an interest-free loan is received by an employee in order to acquire shares of his employer, then interest on money borrowed by his employer to make the loan will be deductible.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 15 - Subsection 15(2) 24

79 C.R. - Q.3

Interest is deductible on loans used to acquire preference shares convertible into common shares, on prime-rate loans where there is a reasonable expectation of a net return, on loans used by a shareholder to make an interest-free loan to a corporation where specified conditions are met, and on loans used to acquire shares of a public company which give an investor the choice of stock or cash dividends, or the right to convert from one class to another. Where money is loaned at no interest to other than a Canadian corporation, RC does not consider the interest expense to be deductible.

Position re deductibility of interest on money borrowed by a corporation to redeem its shares.

79 C.R. - Q.6

Since an investor in a MURB is not allowed by RC to use the cash method, interest expense incurred by him with respect to a MURB is deductible only in the year in respect of which it is payable.

ATR-44

Where a parent company borrows money from a bank at prime plus 1%, uses the borrowed funds to invest in common shares of a newly-incorporated subsidiary which, in turn, subscribes for preference shares of a start-up subsidiary bearing a cumulative dividend of prime plus 1.25%, and the subsidiary loans the same funds on a limited-recourse basis to the parent for a five-year period at prime plus 1%, the interest expense of the parent will be deductible.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) 37

IT-80 "Interest on Money Borrowed to Redeem Shares, or to Pay Dividends".

IT-346R "Commodity Futures and Certain Commodities"

interest on borrowings used to finance futures or commodity transactions that are given capital treatment will not be deductible (unlike the deductibility of interest borrowed to finance such transactions on income account).

Articles

Jack Bernstein, Francesco Gucciardo, "Canada-U.S. Hybrid Financing – A Canadian Perspective on the U.S. Debt-Equity Regs", 26 September 2016, p. 1151

Description of financing by U.S. lender of Canadian real estate company (Canadian RealCo) through hybrid debt (pp. 1158-1159)

[I]nstead of [the U.S. taxpayer] investing in shares of the Canadian RealCo, a debt structure may be created that has the economics of a share investment. …

The U.S. taxpayer may lend funds to the Canadian RealCo at a reasonable rate of interest. The U.S. taxpayer may through another entity make a second loan that would be participating as to profits. Interest on a participation in a loan is not deductible in Canada; rather it is treated as a dividend subject to Canadian withholding tax. Because the U.S. taxpayer owns no shares, there would be no thin capitalization restrictions, no "taxable Canadian property" or section 116 clearance concerns that normally arise on a share sale, and Canadian withholding tax is limited only to the participating interest.

Buttressing U.S. equity treatment (p. 1159)

To ensure that the loans are treated as equity for U.S. tax purposes, if desired by the U.S. lender, there can be an inter-creditor agreement that the simple interest loan will never be sold without the participating loan. The loan agreement may contain negative covenants for the borrower to allow the requisite veto of business decisions in the Canadian company by the U.S. resident….Only interest payments would be made until a sale unless there was a refinancing. The intended result is for the U.S. to regard the two loans combined as equity.

Potential non-application of proposed Code s. 385 Regs. (p. 1159)

The U.S. lender may not otherwise have an equity interest in Canada RealCo, and, if it did, it may not exceed a threshold of 50 percent ownership in Canadian RealCo that would otherwise render it a related party in the first place. This fact alone could cause the transactions to fall outside the proposed regulations. However, if the ownership interest (if the investment were equity) were sufficient to cause the U.S. lender to be related to Canadian RealCo, then, like the forward share subscription financing structure, the efficiency arises as a consequence of treating what is, in form, debt as equity. In other words, if applicable, a recharacterization under the proposed regulations might actually assist in achieving the desired tax outcome.

The impact to Canada RealCo should be irrelevant because it should not be a CFC of the U.S. lender.

Marie-Andrée Beaudry, Dean Kraus, "Selected Income Tax Considerations in the Court-Approved Debt Restructurings and Liquidations", 2015 Annual CTF Conference paper

Non-deductibility of post-CCAA-stay interest (p. 13:29)

[C]reditors are only prevented under the CCAA stay from enforcing the debtor company's obligations. If a plan is not successful, the creditors can enforce payment and the debtor is required to pay all interest, including the interest that accrued following the initial order. …

Regardless, the outcome in Nortel finally confirms that interest should no longer be deductible under paragraph 20(1)(c) unless otherwise provided for in the plan.

Marie-Eve Gosselin, Paul Lynch, "A Review of Interest Deductibility Since Ludco", 2015 CTF Annual Conference paper

Purpose test not an anti-avoidance tool (p.7:10)

Novopharm can be seen as confirmation that the purpose test in subparagraph 20(l)(c)(i) cannot be used by the courts as an anti-avoidance tool-- that is, to defeat plans that are motivated by tax avoidance…[I]n Novopharm, the sole objective of the transactions, when viewed as a whole, was tax avoidance. Nevertheless, the Federal Court of Appeal allowed the interest deduction under subparagraph 20(1)(c)(i).

Swirsky - profitable company with no policy of not paying dividends (p.7:12)

[I]t is the end result in Swirsky that is difficult to absorb in light of the facts reported. When shares of a profitable corporation are acquired with borrowed funds, unless the company has a clear policy against paying dividends, taxpayers should not have to go out of their way to establish some specific expectation of dividend income. …

CRA challenges to intercompany interest charges (p.7:18)

We have seen challenges [to the reasonableness of the interest rate] in related groups, between sister companies, parents and subsidiaries, and cross border hybrid debt structures. The CRA is using its valuation experts to prepare an analysis of the reasonableness of the interest rate. We have seen significant reductions to interest rates claimed to nominal amounts and in some cases zero. Valuation is not an exact science, and frequently mid-range values become the settlement zone. As a practice point, undertaking some type of interest rate analysis, but not necessarily a full valuation, is useful evidence.

Adjustment to recipient's interest inclusion (p. 7:18-7:19)

A second problem with such adjustments is that they are one-sided. If the debt is within the group, interest expense could be denied, yet the interest income would remain fully taxable.

In some instances, we have seen CRA apply a policy first outlined in 1986 at the Canadian Tax Foundation's Annual Conference [in response to Question 39] to reduce interest income of the recipient entity. ... This position was confirmed as valid in a CRA technical interpretation. [f.n. 45...2012-0440071E5.]

Interest deduction following share redemption in exceptional circumstances (p.7:20)

5) In the case of a redemption of shares, the interest expense will generally not be deductible because the direct-use requirement for the borrowed funds will not be met; instead, the corporation must be able to show exceptional circumstances or otherwise rely on the fill-the-hole theory to support its interest deduction;

6) When a redemption of shares occurs in the context of a shareholder dispute, exceptional circumstances can be demonstrated if the corporation submits detailed evidence to show the detrimental impact of the dispute on its day-to-day operations and how the redemption had the effect of preserving or improving the company's income-earning capacity;

Nathan Boidman, Héléné Gagné, Michael Kandev, "Interest Deductibility in Canada: What's the Fuss?", Tax Notes International, July 13, 2015, p. 16.

TDL applied indirect use test (p. 165)

TDL Group

[T]he Tax Court looked at the indirect se of the borrowed funds; namely, the direct use of them by Tim's U.S., to disallow the contested interest deduction. This seems to invert the principle that the indirect use of borrowed funds may be looked at in some circumstances as an exception to the direct use requirement in order to allow interest deductibility, not to disallow it.

Folio reference to Mark Resources (p. 165)

[I]ncome Tax Folio S3-F6-C1…[n]ow adds that…

I]f a corporation with respect to its dividend policy, or its policy is that dividends will be paid when operational circumstances permit, the purpose test will likely be met.

[I]n Mark Resources Inc. the Tax Court of Canada disallowed a corporation's deduction for interest on borrowed money used to make a contribution of capital to its foreign subsidiary. The Court determined that the real purpose of the borrowing was to enable the Canadian corporation to absorb into its income the losses of its foreign subsidiary.

Mark Resources deals with obsolete statutory schemeand is outlier respecting s. 20(1)(c) use test (p. 166)

The inclusion of the reference to Mark Resources in the recent folio is puzzling. First… it is now no longer possible for FAPI to be reduced by losses from an active business. Under the current rules, the loss deductible by virtue of variable F in the computation of FAPI is prescribed by regulation 5903(1), which was amended for tax years after 1994 to the effect that losses from an active business are ring-fenced and would no longer be deductible, under F, in computing FAPI. Therefore, the interest income earned by the U.S. subsidiary… would be attributed to, and taxed in the hands of, the Canadian parent… .

Second, the main and unsuccessful challenge to the plan in Mark Resources was under the relatively narrow predecessor to Canada's GAAR. [fn 23: Section 245… a rule attacking artificial deductions… .] Had the current GAAR been available, it seems likely that Judge Bowman (as he then was) would have applied it. In fact, the court's analysis (that the tax result sought by the taxpayer was not contemplated by the Canadian income tax system and was not consistent with the scheme of the act) is unfounded in the wording of section 20(1 )(c), but is consistent with the type of reasoning expected under the GAAR.

Finally, Mark Resources is a clear outlier in terms of the application of section 20(l)(c). The repeated qualification by Bowman of the purpose test in section 20(l)(c) by the use of terms such as "real" and "true" allowed him to depart from the statutory requirements of this provision and reach a pragmatic result consistent with his obvious dislike for the tax plan that was implemented.

Jack Bernstein, Francesco Gucciardo, "Update on Canada-U.S. Merges and Acquisitions", Tax Notes International, March 16, 2015, p. 993.

Example of a Canadian inbound double-dipping financing strategy: cashless application of cross-border interest payments (owing by Canco to USCo) to satisfy a subscription obligation for shares of Canco, which is targeted to generate interest deductions in Canada and no income inclusions in the U.S. (p. 1001)
  1. Canadian Inbound — Forward Subscription Method

A U.S. corporation (USCo) may enter into a double-dip forward subscription financing arrangement with a Canadian operating company (Canco).

USCo can form a U.S. limited liability company and a Canadian acquisition company (in this case, the purchaser would not use a ULC or convert a target to a ULC). LLC will file a protective check-the-box election to be treated as a disregarded entity for U.S. tax purposes.

USCo will subscribe for sufficient common shares of the Canadian acquisition company to satisfy Canada's thin capitalization requirements. U.S. purchaser will borrow funds from a U.S. bank and lend the funds at a market interest rate to the Canadian acquisition company. The loan will be equal to 1.5 times the equity or 60 percent of total funding (Canadian thin capitalization restriction). The subscription and loan proceeds will be used to fund the acquisition of a Canadian target following which the Canadian acquisition company and Canadian target will be amalgamated to form Canco.

The loan will have a maturity date and will not be assignable and will be secured. USCo will enter into a forward subscription agreement or support agreement with LLC to subscribe for membership interests equal to both the principal amount of the loan and the interest as principal and interest under the loan become due. LLC will enter into a similar forward subscription agreement with the Canadian acquisition company (predecessor to Canco) to subscribe for shares in the Canadian acquisition company (predecessor to Canco) equal to both the principal amount of the loan and the interest as principal and interest under the loan become due. Funds will be paid under both forward subscription agreements on the dates that interest or principal payments are required under the loan. As interest becomes payable it will, in effect, be retained by the Canadian acquisition company through directions on account of the subscription price for shares by LLC under the forward subscription agreement:

  • Canco pays interest on debt to USCo;
  • USCo directs that the amount be paid to LLC under its support obligations; and
  • LLC redirects that Canco retain the amount on account of the subscription price for shares of Canco under the forward subscription agreement — Canco issues shares to LLC.

The objective for U.S. federal income tax purposes is for the loan, both forward subscription agreements, and the issuance of common shares of the Canadian acquisition company to be treated as an integrated instrument such that the loan is treated as equity rather than debt for U.S. federal income tax purposes. Structured properly, the shares issued by the Canadian acquisition company in connection with the share subscription by LLC under the forward subscription agreement (using the funds paid by the Canadian acquisition company on account of the interest on the loan) should be treated as a tax-free stock dividend for U.S. federal income tax purposes.

The issuance of shares in the course of the transactions is intended to be treated as a tax-free stock dividend for U.S. federal income tax purposes, while the payment of interest by Canco to USCo is a deductible expense with no withholding consequences in Canada (Canada respects the form of the instrument).

Joseph Frankovic, "Supreme Court to Consider GAAR in Lipson Appeal", CCH Tax Topics, April 10, 2008, No. 1883, p. 1

Charles Taylor, "Hybrid Instruments and Linked Instruments", 2005 Conference Report, c. 16.

Dominic Belley, "Interest Deductible Notwithstanding Form of Contract", Tax for the Owner-Manager, Vol. I, No. 2, April 2001, p. 7

Discussion of Vanier case of the Cour du Québec.

Tim Edgar, "The Concept of Interest under the Income Tax Act", 1996 Canadian Tax Journal (Vol. 44), p. 277.

Larry F. Chapman, John M. Ulmer, "Canada", Tax Treatment of Hybrid Financial Instruments in Cross-Border Transactions, International Fiscal Association, Vol. LXXXVa, p. 207.

Lewis, "The Taxation of Structured Settlements", British Tax Review, 1994, No. 1, p. 19

A discussion of authorities supporting the position of Inland Revenue that the full amount of payments under a structured settlement are instalments of capital and not income.

Leslie Morgan, Chris Van Loan, "Recent Developments Involving Tier One Capital Innovative Instruments", Corporate Finance, Vol. VIII, No. 1, 2000, p. 705

K. Penny, "The Toronto-Dominion Bank/Templeton Growth Fund Linked Notes", Corporate Finance, Vol. 6, No. 2, 1998, p. 494.

Edgar, "The Concept of Interest Under the Income Tax Act", 1996 Canadian Tax Journal, Vol. 44, No. 2, p. 277.

Tax Management Financial Products Report

, "Lack of Time, Resources Stem Overhaul of Canadian Tax Legislation, Official Says", Vol. 1, No. 1, 15 March 1996, p. 14.

Smith, "Recent Transactions: Debt", 1993 Conference Report, C. 19

Discussion of Hollinger LYONS and WIC Transactions; and interest deductibility issues respecting special debenture warrants and debenture instalment receipts.

Tremblay, "Foreign Tax Credit Planning", 1993 Corporate Management Tax Conference Report, c. 3, pp. 3:29-3:31

Discussion of the situation where a Canadian parent borrows funds used to capitalize its U.S. lending subsidiary and the U.S. withholding tax on dividends from the subsidiary eliminates a reasonable expectation of profit.

Richardson, "New Financial Instruments: A Canadian Tax Perspective", 1992 Corporate Management Tax Conference Report, c. 9

Discussion of the jurisprudence on the deductibility of interest.

Arnold, "Is Interest A Capital Expense?", 1992 Canadian Tax Journal, No. 3, p. 533.

Flatters, "Assumption of Debt Obligations", 1992 Canadian Tax Journal, Issue No. 2, p. 469.

Dickson, Arnold, "Rubbing Salt into the Wound: The Denial of the Interest Deduction after the Loss of a Source of Income", 1991 Canadian Tax Journal, p. 1473.

Ewens, "Debt-For-Debt Exchanges", 1991 Canadian Tax Journal, p. 1615.

Arnold, Edgar, "Reflections on the Submission of the CBA-CICA Joint Committee on Taxation Concerning the Deductibility of Interest", 1990 Canadian Tax Journal, p. 847.

Brussa, "Strategies for Troubled Times", 1990 Conference Report, c. 9

Crawford, "The Deductibility of Interest", 1990 Conference Report, p. 4:10

Discussion of interest deductibility issues respecting the assumption of debt.

Subparagraph 20(1)(c)(i)

See Also

Cassan v. The Queen, 2017 TCC 174

interest on loan to acquire LP units was deductible as there was a prospect of gross income being allocated by LP in 19 years’ time

In December 2009, the taxpayers participated in a program that had both an investment and gifting component. Under the investment component:

  1. The taxpayer purchased a minimum of 10 limited partnership units (the “LP Units”) in an Ontario limited partnership (the “2009 LP” – whose general partner was owned by a family trust of the owner of the promoter (“EquiGenesis”)) for $36,140 per LP unit, of which $32,000 was funded by a loan (a “Unit Loan,”) – which had a maturity date in February 2019, was secured by a pledge of the LP Units, bore interest at 7.85%, all of which in fact was funded with further cash advances from the lender (“capitalized interest”), who was a trust (“FT”) - and the balance was funded by the taxpayer.
  2. The 2009 LP used these per-unit proceeds to pay $1,565 in issue expenses and $34,575 to purchase “Linked Notes” (issued by “Leeward,” a BVI corporation), which provided for the payment on their maturity on December 31, 2028 of their $34,575 principal plus the greater of two amounts, each calculated by reference to a notional portfolio.
  3. Leeward made a secured loan of $32,000 of the amount so received to a trust affiliated with FT (“DT”), which immediately lent the same amount as a secured loan to FT, with each loan bearing interest at 7.85% p.a. and maturing on December 31, 2028.

Leeward also invested $2,575 in Class D Notes (the “Man Notes”) issued by a U.K.-based investment manager (“Man Investments”) and with a return dependent on the return realized on an underlying pool of assets managed by it. The return on the Man Notes to December 31, 2028 was required to be at least 9.61% p.a. in order for Leeward to be able to discharge notes (owing to a charity arising under the gift component and which had priority over the Linked Notes) when they matured in 2028.

After finding that the 2009 LP was not required to accrue interest income under Reg. 7000(2)(d), Owen J rejected a Crown submission that the interest incurred by the taxpayers on their loans from FT were not deductible under s. 20(1)(c), stating (at paras. 418-9):

Regardless of the amount Leeward owes to the 2009 LP on the maturity of the Linked Notes, the amount that will be paid by Leeward to the 2009 LP in satisfaction of the Linked Notes cannot be greater than the assets of Leeward at the time less the amount payable by Leeward to TGTFC under the TGTFC Notes. The assets of Leeward are comprised of the Man Notes and the loans to DT.

Notwithstanding this practical limitation, the 2009 LP will be required to include in income under paragraph 12(1)(c) the full amount of the return on the Linked Notes. If Leeward does not pay the full amount of the return owing to the 2009 LP on the maturity of the Linked Notes, the 2009 LP is expected to claim a deduction from income under paragraph 20(1)(p) equal to the shortfall.

In rejecting a Crown submission that the taxpayers’ purpose was to realize a capital gain on the sale of their units of the 2009 LP rather than being allocated income on their units of the 2009 LP, he noted (at para. 422) that there was no identifiable buyer for the LP Units.

Finally, he stated (at para. 436):

[T]he fact that the reasonably expected gross income is expected to be realized on December 31, 2028 is not a consideration raised by paragraph 20(1)(c) of the ITA. The paragraph dictates the timing of the deduction of the interest expense and does not require that the deduction be matched to the income from the business or property.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 118.1 - Subsection 118.1(1) - Total Charitable Gifts common law gift was vitiated by loan to donor at unreasonably low rate 746
Tax Topics - Income Tax Act - Section 143.2 - Subsection 143.2(12) although borrowing by taxpayers had a term of 9.3 years, they had a reasonable expectation of refinancing with the promoter’s assistance 466
Tax Topics - Income Tax Act - Section 143.2 - Subsection 143.2(7) - Paragraph 143.2(7)(a) loans were not bona fide in that not handled with commerciality 655
Tax Topics - Income Tax Regulations - Regulation 7000 - Subsection 7000(2) - Paragraph 7000(2)(d) no requirement to accrue interest on index-linked note in a year when the return thereon was not determinable 577
Tax Topics - Statutory Interpretation - Realization Principle amount should not be recognized until ascertainable 67
Tax Topics - Income Tax Act - Section 69 - Subsection 69(1) - Paragraph 69(1)(c) gratuitous transfer is gift irresepctive of absence of benevolent intent 50

Administrative Policy

3 November 2017 External T.I. 2017-0712141E5 F - Borrowing to make interest-free loans

interest on shareholders’ borrowings to fund an interest-free corporate loan may be deductible even if the proportionate-to-shares test is not met

The common shares of XY Inc. (with an active business) are held equally by the two holding companies for X and Y (namely, X Inc. and Y Inc.), and X and Y each holds a preferred share (or, alternatively, a common share) of XY Inc. directly. Would interest on bank loans used by X Inc. and Y Inc. to make equal (or unequal) non-interest bearing loans to XY Inc. be deductible? After referencing the general principle that “interest expense on borrowed money used to make an interest-free loan … may be deductible … where the facts disclose that the money was borrowed for an indirect current use whose purpose was the earning of income from a business or property,” CRA stated:

The CRA generally agrees that this is the case where, firstly, the interest-free loan affects the corporation's capacity to earn income and, furthermore, the interest-free loan is granted to a corporation by its sole shareholder or, if there are several shareholders, each shareholder has granted an interest-free loan to the corporation in proportion to the shareholder’s interest in the corporation.

In other situations, the taxpayer must demonstrate that making an interest-free loan to a corporation affects the taxpayer's income-earning capacity and, therefore, that there is a sufficient link between the interest-free loan and a source of the taxpayer's income. In this regard, the principles followed in … Canadian Helicopters … could be useful.

2016 Ruling 2015-0602711R3 - Interest on Notes to Non-Residents

deductible interest on subordinated debt with mandatory insolvency conversion
Note terms with contingent mandatory conversion event

ACo will issue pursuant to the Trust Indenture subordinated indebtedness (“Notes”) in one or more public offerings in Canada and elsewhere to arm’s length purchasers. The Notes will bear interest at a fixed annual rate until the Interest Reset Date, after which they will bear interest on a specified basis plus a fixed spread. No interest on the Notes will accrue or be payable after the date of a XXXXXXXXXX Event (a “Mandatory Event”). On the occurrence of a Mandatory Event, the Notes will be converted into preferred shares at a conversion ratio of one preferred share for each Note plus a fractional preferred share in respect of accrued but unpaid interest except that for foreign securities’ law purposes, ACo may instead seek to sell the preferred shares on the foreign holder’s behalf. There is acceleration on default, and a specified maturity date.

Rulings

Re s. 20(1)(c)(i) deduction and interest not being “participating debt interest.”

The CRA summary states:

The borrower-lender relationship will continue to exist until such time as a [mandatory conversion event] occurs or until such time as it is or it became apparent the [mandatory conversion event] would occur.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(3) - Participating debt interest interest ceasing after insolvency event not problematic 92

14 June 2017 External T.I. 2016-0666411E5 - Negative returns on investments

negative interest not a contra to positive interest

CRA was asked whether a negative interest rate borne on a deposit with a financial institution would be deductible by the depositor. It was assumed that in each year there would always be some months in which the deposit bore positive interest.

CRA responded that the negative interest was not a contra item to the interest income generated in the year, but that such negative return would likely be deductible under s. 9 given that there was a reasonable expectation of earning interest income on the deposit in the year. CRA stated:

The negative return to the client would ... not represent compensation for the use of money and would not constitute interest (or negative interest) to the client. Accordingly, it is our view that the positive interest on the Deposits would not be offset or reduced by the negative returns.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(a) - Loans and Financing Charges negative interest is deductible under s. 9 if there is a reasonable expectation of receiving (positive) interest 130
Tax Topics - Income Tax Act - Section 40 - Subsection 40(2) - Paragraph 40(2)(g) - Subparagraph 40(2)(g)(ii) capital loss on loan with nil interest rate may be denied by s. 40(2)(g)(ii) 107

26 May 2016 Internal T.I. 2016-0628741I7 - Interaction of s. 80 and s. 143.4

interest only deductible in the year paid or payable

The Taxpayer, which for a number of years had gone without paying interest on its Notes, mostly had not deducted the amounts of the accrued but unpaid interest (which remained unpaid). However, in its return for the year preceding that of implementation of a Plan of Compromise, the Taxpayer added such amounts to its non-capital losses at the beginning of the year.

CRA indicated, in light of the requirement in s. 20(1)(c)(i) that only interest paid or payable in respect of the year may be deducted in that year, pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property, the Taxpayer could not deduct the total unclaimed interest expense in the described year, it could request adjustments in respect of the unclaimed interest deductions for the preceding years, as there were non-capital losses in those years that were utilized in the year of the compromise.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 80 - Subsection 80(2) - Paragraph 80(2)(a) no settlement of debt under Plan before conditions precedent fulfilled 158
Tax Topics - Income Tax Act - Section 143.4 - Subsection 143.4(1) - Right to reduce right to reduce notwithstanding that conditions precedent to interest forgiveness not yet satisfied 311
Tax Topics - Income Tax Act - Section 143.4 - Subsection 143.4(4) s. 143.4(4) caused an immediate income inclusion of prior years’ interest that was to be forgiven at a later date under an approved Plan of Compromise 175

14 March 2016 Internal T.I. 2015-0609671I7 - Earnout, Amalgamation, Cost of Shares and ECE

position on interest deductibility following target amalgamation is based on policy and ITA scheme rather than technical

A Canadian Acquisitionco acquired Canadian Targetco for a cash base price plus earnout obligations, and then immediately merged with Targetco under a short-form amalgamation. The Rulings Directorate rejected Amalco’s treatment of the earnout payments subsequently made by it as eligible capital expenditures. In the course of addressing its submission that, by analogy to CRA’s position that interest on a borrowing to acquire shares of a target continued to have the original purpose following the disappearance of the target shares on amalgamation and the direct holding of the underlying income-producing assets, the earn-out payments also had an income-producing purpose stated:

[A]lthough we indicated at the 2002 Annual Conference of the Canadian Tax Foundation that our position regarding the deductibility of interest in the context of a leveraged buy-out followed by an amalgamation was supported by the flexible approach of linking adopted... Ludco…there is no “tracing” of the assets of the amalgamated corporation as a replacement or substitution for the shares of the target corporation that no longer exist following the amalgamation. While it might be argued that the amalgamated corporation “acquires” the assets of the predecessor corporations upon the amalgamation, the assets are not legally replacing the shares of the predecessor corporations. Notwithstanding this technical difficulty, from a policy standpoint, it was the CRA’s view that interest should be deductible in the context of a leveraged buy-out followed by an amalgamation. Our position is supported by the general scheme of section 87 which is to treat the amalgamated corporation as a continuation of the predecessor corporations standing in their place with respect to assets, liabilities and tax accounts. Of particular relevance is the rule in subparagraph 87(2)(c)(ii), which provides that the amalgamated corporation may deduct in computing its income for a taxation year any amount paid or payable by it in that year that would, if it had been paid or payable by the predecessor corporation in its last taxation year, have been deductible in computing the income of the predecessor corporation for that year.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 88 - Subsection 88(1) - Paragraph 88(1)(d) post-amalgamation earnout payment could be applied to increase an s. 88(1)(d) bump of capital property (but not ECP) of the amalgamated target 299
Tax Topics - Income Tax Act - Section 14 - Subsection 14(5) - Eligible Capital Expenditure payments made by Amalco in satisfaction of earnout obligation for acquisition of one precedessor by the other were not ECE 204
Tax Topics - Income Tax Act - Section 54 - Adjusted Cost Base earnout payments an addition to cost of shares which had since disappeared 78
Tax Topics - General Concepts - Purpose/Intention attribution of predecessor's intention to Amalco 132

10 October 2014 APFF Roundtable, 2014-0534811C6 F - Interest deductibility

no deductibility if permanent policy of not paying dividends

(a) Could CRA confirm its position in IT-533, para. 31 notwithstanding certain comments in Swirsky? (b) Does CRA recognize that numerous years may pass before a corporation pays dividends, for example, a mineral or petroleum corporation at the exploration phase, without compromising interest deductibility on a loan incurred to acquire common shares? CRA responded (TaxInterpretations translation):

(a) The comments of the Tax Court of Canada in the Swirsky case respecting the absence of a history of payment of dividends have not effected a modification to our position in paragraph 31 of Interpretation Bulletin IT-533 respecting the deductibility of interest on a money borrowed for the purpose of acquiring common shares. Thus, where a taxpayer incurs a loan in order to acquire such shares on which no dividends have been paid, the interest respecting the loan will be deductible if we consider that at such moment there is a reasonable expectation of eventually receiving dividends on such shares. ...

(b) By itself, the fact that a corporation utilizes its entire liquidity for the purposes of carrying on its business for a certain period does not generally have the effect of limiting the potential for one of its shareholders to claim a deduction by virtue of subparagraph 20(1)(c)(i)...in respect of money borrowed for the purpose of acquiring its shares. However, we would conclude that there is not a reasonable expectation of receiving dividends when the facts and documents indicate clearly that the permanent policy ["politique permanente"] of the corporation is to not pay dividends on the shares in question.

Subparagraph 20(1)(c)(ii)

Administrative Policy

2016 Ruling 2016-0635051R3 - rollout property to beneficiary non-resident trust

secured and intergroup debt assumed on s. 107(2) rollout of property qualified under s. 20(1)(c)(ii)

CRA ruled that the s. 107(2) rollover applied to the distribution by a non-resident trust, to which s. 94(8.2) (or s. 75(2)) no longer applied because its settlor had been dissolved, of Canadian rental property to its sole beneficiary, which was a (presumably non-resident) corporation related to the Canadian-resident lessee of the property. CRA also ruled that mortgage debt, and unsecured debt owing to a group “Finco,” that was assumed on the distribution, qualified as an amount payable for the property by the beneficiary for purposes of s. 20(1)(c)(ii).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - 101-110 - Section 107 - Subsection 107(2) s. 107(2) rollout of taxable Canadian property by a non-resident former s. 75(2) trust to its corporate beneficiary 365
Tax Topics - Income Tax Act - 101-110 - Section 107 - Subsection 107(4.1) rollout under s. 107(2) available following dissolution of settlor of s. 94(8.2) trust 70

2015 Ruling 2015-0601441R3 - XXXXXXXXXX Partnership - winding up

interest deductible following assumption of interest-bearing internal debt on s. 98(5) wind-up
Current structure

Sub1 and Sub2 (both taxable Canadian corporations and wholly-owned subsidiaries of Parent) are currently the sole partners of a general partnership (“Partnership”). Partnership carried on an active business. Sub1 was indebted to Partnership under the demand non-interest bearing “Sub1-Partnership Note”), and Parent was indebted to Partnership under the “Parent-Partnership Note,” which was interest bearing and payable on demand.

Proposed transactions
  1. Sub1 will repay the Sub1-Partnership Note by assuming Partnership’s accounts payable.
  2. Sub1 will assume all indebtedness of Partnership, including the Partnership-Parent Note and Partnership’s obligation to pay “Employee Accruals” under various compensation and retirement plans in consideration for additional Partnership Units.
  3. Sub2 will transfer its interest in Partnership to Sub1 in consideration for Sub1 Preferred Shares and a non-interest bearing promissory note (the “Sub1 Note”), jointly electing under s. 85(1). As a consequence Partnership will cease to exist, Sub1 will become the sole owner of all the Partnership property and Sub1 will become subject to all the remaining obligations of Partnership, and immediately after the time that Partnership ceased to exist, Sub1 will carry on alone the business that was the business of Partnership.
Ruling

Interest paid or payable by Sub1 in respect of any debt obligation of Partnership, including the Partnership-Parent Note, assumed by Sub1 as a consequence of the dissolution of Partnership will be deductible by Sub1 under paragraph 20(1)(c) to the same extent that such interest would have been deductible by Partnership if Partnership did not dissolve provided that Sub1 uses the property acquired from Partnership for the purpose of earning income from a business or property (other than income which is exempt or property that is a life insurance property).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 98 - Subsection 98(5) 98(5) wind-up through s. 85 transfer of partnership interest of one partner to the other and preceded by debt assumptions 272
Tax Topics - Income Tax Act - Section 34.2 - Subsection 34.2(11) continuation of s. 34.2(11) reserve following partnership wind-up 324
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(m) continued availability of s. 20(1)(m) reserve following s. 98(5) wind-up 266
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(n) flow-through of s. 20(1)(n) reserve on s. 98(5) wind-up 262
Tax Topics - Income Tax Act - Section 20 - Subsection 20(24) s. 20(24) election on s. 98(5) wind-up 280
Tax Topics - Income Tax Act - Section 18 - Subsection 18(9) s. 18(9) deduction claimable by transferee former partner following s. 98(5) wind-up 216
Tax Topics - Income Tax Act - Section 147.2 - Subsection 147.2(8) s. 147.2 continuity following s. 98(5) wind-up 336
Tax Topics - Income Tax Act - Section 6 - Subsection 6(1) - Paragraph 6(1)(i) no income inclusion on assumption on s. 98(5) wind-up of DSUs and RSUs 329
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Salary Deferral Arrangements - Paragraph (k) no income on RSU/DSU assumption 20

31 May 2016 Internal T.I. 2016-0638241I7 - interest deductibility

Penn Ventilator affirmed

Canco repurchased common shares held by a non-resident. Has the affirmation in S3-F6-C1, para. 1.65 of Penn Ventilator been changed by A.P. Toldo? In affirming the Folio position, CRA stated:

The Court in A.P. Toldo suggested that the decision in Penn Ventilator should be applied narrowly. However, it is our view that those comments were obiter and somewhat ambiguous. Accordingly, A.P. Toldo has not caused us to change our position.

10 October 2014 APFF Roundtable, 2014-0538141C6 F - Interest deductibility

interest on mortgage assumed on devise of land to beneficiary considered as amount payable for the property
Situation 1

In Situation 1, a trust borrows money under a hypothec to acquire a rental property. The trust distributes the rental property to one of its beneficiaries (A), who assumes the hypothec loan (a charge on the property) and thereafter holds the property for the generation of rent.

Situation 2

In Situation 2, an individual (B) borrows money to acquire a rental property. After death, the rental property is devised to B's child (Child). "The legacy ["legs"] is charged with the hypothec and, consequently, Child assumes the balance owing of the hypothec loan," with the property thereafter used by Child for rental purposes. In both Situations, is the interest deductible under s. 20(1)(c)(ii) following the distribution?

CRA stated (TaxInterpretations translation):

Situation 1

. To the extent that the assumption by A of the hypothec loan charging the property is a condition of the distribution…the balance owing under the hypothec loan constitutes "an amount payable a property acquired" for the purpose of ITA subparagraph 20(1)(c)(ii). …

Situation 2

Similarly, the CRA considers that the balance owing under the hypothec loan assumed by Child in the circumstances constitutes "an amount payable a property acquired"… .