Principal Issues: Will interest on a line of credit be deductible against revenues where a sole proprietor co-mingles sales revenues with personal funds and utilises the co-mingled funds to pay down a personal mortgage while a line of credit is solely utilised for payment of the proprietorship's business expenses?
Position: Yes
Reasons: Cash damming as discussed in IT-533, paragraph 16.
2006-021824 XXXXXXXXXX L. Carruthers, CA 613-957-2060 August 14, 2007
Dear XXXXXXXXXX:
Re: Interest Deductibility - Cash Damming
This is in reply to your letter of December 15, 2006, and our telephone conversation of August 10, 2007, wherein you asked our assistance to clarify the interest deduction that would be allowed on a line of credit based on the example that follows:
A sole proprietor co-mingles sales revenues with personal funds and utilises the co-mingled funds to pay down a personal mortgage while a line of credit is solely utilised for payment of the proprietorship's business expenses.
Our Comments:
Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject of an advance income tax ruling request submitted in a manner set out in Information Circular 70-6R5. (This Information Circular and the Interpretation Bulletin referred to below can be accessed on the internet at http://www.cra-arc.gc.ca.) As stated in paragraph 22 of Information Circular 70-6R5, written opinions are not advance tax rulings and, accordingly, are not binding on the Canada Revenue Agency (the "CRA"). The following comments are, therefore, of a general nature only.
Paragraph 20(1)(c) of the Income Tax Act (the "Act") governs the deductibility of interest expense for income tax purposes and, for purposes of your example, generally, limits the deduction to interest on borrowed money which is used for the purpose of earning income from a business or from property. Interpretation Bulletin IT-533, entitled Interest Deductibility and Related Issues, discusses the CRA's interpretations of the deductibility of interest expense under various provisions of the Act and the judgments in numerous court decisions involving the deductibility of interest expense. The courts (as commented on in IT-533) have determined that it is the direct use to which the borrowed money is applied which governs whether the interest is deductible for tax purposes.
In our view, the cash damming techniques discussed in paragraph 16 of IT-533 include the scenario you described and would serve to ensure that borrowed monies are used for specific, and presumably, eligible uses. The CRA accepts that cash damming is consistent with the wording of paragraph 20(1)(c) as well as court decisions and serves to facilitate the tracing/linking process.
We trust our comments are of assistance.
Yours truly,
R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate