Principal Issues: Will interest paid on borrowed money, used for the purpose of investing in common shares, be deductible where no income has been earned from the common shares.
Position: Taxpayer's request was forwarded to the appropriate Tax Centre.
Reasons: Question relates to an actual situation in prior taxation years.
August 10, 2010
Tax Centre HEADQUARTERS Post Office Box 14001, Station Main Income Tax Rulings Winnipeg MB R3C 3M3 Directorate Attention: Individual Client Services L. Carruthers, CA and Benefits Division 613-260-9630 2010-037671
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Taxation Years 2006 - 2009
We are writing as a result of the attached correspondence we received from XXXXXXXXXX , wherein the above-noted taxpayer (the "Taxpayer") requested our technical interpretation as to whether the interest paid on borrowed money (the "Borrowed Money"), used for the purpose of investing in common shares of XXXXXXXXXX (the "Common Shares"), would be deductible where no income was earned from the Common Shares.
As noted in the attached correspondence, in XXXXXXXXXX , the Taxpayer purchased the Common Shares with the Borrowed Money. The Taxpayer deducted his interest expense for the Borrowed Money in his XXXXXXXXXX taxation years. Subsequently, he became concerned that this interest expense was not an eligible deduction and, therefore, he recently filed T1 Adjustment (a "T1-ADJ") Requests for his XXXXXXXXXX taxation years. It appears that the Taxpayer did not deduct his interest expense for the Borrowed Money in his XXXXXXXXXX taxation year.
In the attached T1-ADJs, the Taxpayer now requests that his XXXXXXXXXX taxation years be re-adjusted to increase his line 221 interest deduction, "IF it has been deemed allowable by the Income Tax Rulings Directorate". It appears that the Taxpayer is seeking confirmation that his interest expense for the Borrowed Money is an eligible deduction and, if so, he seeks to be re-assessed in accordance with his original filing position, i.e., prior to the first set of T1-ADJs noted in the previous paragraph.
Our Comments
The attached correspondence describes an actual and completed transaction in prior taxation years. This Directorate does not give taxpayers written confirmation of the tax implications inherent in completed transactions. Rather, taxpayers should submit all relevant facts and documentation to the appropriate tax services office for their views.
This Directorate is also not the correct recipient of the attached T1-ADJ Requests. Rather, as you are aware, the responsibility for delivering Taxpayer Requested Reassessment Services to a taxpayer residing in Alberta rests with the Winnipeg Tax Centre, Individual and Benefit Services Division. Therefore, we are forwarding the attached correspondence to you for consideration and, should you or the relevant tax services office request assistance, we could provide you with our technical interpretation of the given situation.
For your information, we have attached a copy of our letter, 2008-0275171E5, which we previously wrote on a subject similar to the Taxpayer's request. We would also like to draw your attention to the following paragraph from Interpretation Bulletin IT-533 Interest Deductibility and Related Issues:
"Borrowing for investments including common shares
¶ 31. Where an investment (e.g., interest-bearing instrument or preferred shares) carries a stated interest or dividend rate, the purpose of earning income test will be met "absent a sham or window dressing or similar vitiating circumstances" (Ludco). Further, assuming all of the other requisite tests are met, interest will neither be denied in full nor restricted to the amount of income from the investment where the income does not exceed the interest expense, given the meaning of the term income as discussed in ¶ 10.
Where an investment does not carry a stated interest or dividend rate such as some common shares, the determination of the reasonable expectation of income at the time the investment is made is less clear. 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. Nonetheless, each situation must be dealt with on the basis of the particular facts involved.
These comments are also generally applicable to investments in mutual fund trusts and mutual fund corporations.
Example 8
R Corp. is an investment vehicle designed to provide a capital return only to the investors in its common shares. The corporate policy with respect to R Corp. is that dividends will not be paid, that corporate earnings will be reinvested to increase the value of the shares and that shareholders are required to sell their shares to a third-party purchaser in a fixed number of years in order to realize their value. In this situation, it is not reasonable to expect income from such shareholdings and any interest expense on money borrowed to acquire R Corp. shares would not be deductible.
Example 9
S Corp. is raising capital by selling common shares. Its business plans indicate that its cash flow will be required to be reinvested for the foreseeable future and S Corp. discloses to shareholders that dividends will only be paid when operational circumstances permit (i.e., when cash flow exceeds requirements) or when it believes that shareholders could make better use of the cash. In this situation, the purpose of earning income test will generally be met and any interest on borrowed money to acquired S Corp. shares would be deductible."
To further assist you in addressing the Taxpayer's request, we are enclosing a number of excerpts from the Corporation's past financial statements and initial prospectus. XXXXXXXXXX
For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the Taxpayer.
R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
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