Principal Issues: whether subsection 15(2) applies to a loan made to a person connected to a shareholder
Position: Question of fact
Reasons: Application of 15(2) and (2.1)
2005-015130
XXXXXXXXXX G. Moore
(613) 957-8982
October 4, 2005
Dear XXXXXXXXXX:
Re: Interest Expense Deduction
This is in response to your letter of September 19, 2005, inquiring about the income tax consequences of a corporation holding a mortgage for your son.
You have asked for our comments in the following scenario:
The mother and father are the shareholders of a corporation. Their son will borrow money from the corporation and use the proceeds to acquire an income-earning property. You asked whether the corporation could invest in a registered mortgage payable by a relative of the shareholder. The terms of the mortgage will be the same as they would be with an arm's length person. The interest paid by the son to the corporation will be deducted as interest expense. Interest earned on the mortgage held by the corporation will be reported as interest income. You indicate that section 15 of the Income Tax Act (the "Act") should not apply as the transaction is not benefiting the shareholders.
The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advanced income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, "Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.
Our Comments
Paragraph 20(1)(c) of the Act governs the deductibility of interest expense for income tax purposes and, generally, that provision limits the deduction to interest on borrowed money which is used for the purpose of earning income from a business or from property. In other words, it is the direct use to which the borrowed money is applied which governs whether the interest is deductible for tax purposes. Generally, mortgage interest costs related to borrowed money used to acquire an income-earning property would be deductible. The CRA's general views regarding interest deductibility are contained in Interpretation Bulletin IT-533. In this regard, the bulletin can be found on our website at: http://www.cra-arc.gc.ca.
Based on the limited information provided, we are of the view that subsection 15(2) of the Act will apply since a person connected to the shareholder will become indebted to the corporation. Subsection 15(2.1) provides that a person is connected to the shareholder if he or she does not deal at arm's length with the shareholder. However, subsections 15(2.2) to (2.6) contain specific exceptions to the application of subsection 15(2). If a borrower can establish that a loan falls within one of these exceptions, the loan will not have to be included in income under subsection 15(2). You may wish to refer to the current version of Interpretation Bulletin IT-119 with respect to the application of 15(2).
We trust that these comments will be of assistance.
Yours truly,
For/Steve Tevlin
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Policy and Planning Branch