Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Canadian Tax Foundation
Corporate Management Tax Conference
June 14, 1996
Question 5 - Interest on Funds Borrowed to Redeem Shares
A private corporation wishes to issue an interest-bearing promissory note to redeem some of its outstanding shares or to reduce capital thereon. The position of Revenue Canada is that interest would not be deductible because the debt would not constitute "borrowed money" nor would it constitute an amount payable for property acquired by the corporation to earn income from the property or a business.
To avoid this problem, the corporation's shareholders borrow funds and re-lend the funds to the corporation in exchange for an interest-bearing note. The corporation uses the cash to redeem the shares or reduce capital, and the shareholders retire their loan. The corporation has therefore borrowed from its shareholders to fund the redemption or reduction of capital.
Alternatively, the corporation borrows from its bank and redeems the shares or reduces the capital, the shareholders loan the funds back in exchange for an interest-bearing note, and the corporation pays out the bank. Again, even taking into account subsection 20(3), the corporation has borrowed to redeem or reduce capital.
In either case, subject to reasonableness of the rate of interest, would Revenue Canada respect the transaction and allow interest deductibility as if the note were owed to an arm's-length bank?
Department's Response
Yes, interest on the note payable to the shareholders would be deductible by the corporation pursuant to paragraph 20(1)(c) to the same extent that interest would have been deductible by the corporation on money borrowed by the corporation from an arm's-length lender and used by the corporation to redeem its shares or to pay an amount to its shareholders on a reduction of its capital.
The Department would not ordinarily seek to apply subsection 245(2) to such an arrangement.
Author: Mark Symes
File: 5-962074
Date: June 11, 1996