Where FA1 borrows $350,000 from a sister (FA3) to make a capital distribution to its Canadian shareholder (Canco) on its Class A common shares, which had previously been issued by it to Canco solely to use the subscription proceeds of $800,000 to finance FA1’s active business, CRA would accept that the interest on the $350,000 loan would be received as deemed active business income by FA3 under s. 95(2)(a)(ii)(B). CRA indicated that this result would obtain even if FA1 had issued shares of another class (its Class B common shares) to Canco, to finance the $200,000 acquisition of shares (of FA2) which were not excluded property, at the same time as it issued the Class A common shares.
In the situation where FA1 was required to compute its income (pursuant to Reg. 5907(1) – earnings – (a)(iii)) under Part I of the Act, CRA indicated that the interest was deductible under s. 20(1)(c) “because the borrowed funds replaced capital that…had been used by FA1 for the purpose of earning income from an active business,” whereas in the situation where the earnings were computed pursuant to (a)(i) or (iii) of the earnings definition under local tax law and the interest was non-deductible under such law, CRA simply stated that the interest would be deductible under Reg. 5907(2)(j).