Principal Issues: [TaxInterpretations translation]
Comments on the forthcoming publication of the Interpretation Bulletin on interest deductibility
Position: General comments.
Reasons:
Position based on current Canadian jurisprudence.
FINANCIAL PRODUCTS ROUNDTABLE
APFF - CONFERENCE 2003
Question 2
Can the CCRA provide an update on the status of the revision of the Interpretation Bulletin on interest deductibility and the content of the new Bulletin?
CCRA Response
As you know, on October 10, 2002, at the conference of this association, we reported the results of our preliminary review of our interpretative and administrative positions on the interpretation of the interest deductibility provisions. A copy of our paper is available on our website at http://www.ccra-adrc.gc.ca/tax/technical/incometax/presentation-e.html. This process included a consultation period during which we received comments on the proposed interpretations. We expect to issue a new Interpretation Bulletin on interest deductibility in the near future that will provide the CCRA's official interpretation. We have distributed a copy of the draft Bulletin to tax practitioners for consultation.
On February 18, 2003, at the time of the federal budget, the Department of Finance announced that it was considering legislative changes with respect to interest charges. On March 27, 2003, the Supreme Court of Canada agreed to hear the appeal of Mr. Thomas Gifford. The Bulletin was made on the basis of the existing law prior to these events, including the decisions of the Supreme Court of Canada in Ludco and Singleton on September 28, 2001.
Question 2.1
Subparagraph 20(1)(c)(i) requires that interest be paid on "borrowed money used for the purpose of earning income from a business or property". Can you provide any guidance as to how the CCRA interprets the terms "used" and "income" following the Shell, Singleton and Ludco decisions?
CCRA Response
The interpretation of the term "income" was addressed in the Ludco case, where it was determined that "income" means income generally, that is, an amount that would come into income for taxation purposes, not just net income.
In general, the applicable test for the use of borrowed money is direct use. There must be a direct link between the borrowed money and the current eligible use. Furthermore, the use of the borrowed money must be established by taking into account the legal relationships resulting from each transaction carried out by the taxpayers. However, in some cases, the courts have stated that indirect use will be accepted, but only as an exception to the direct use test. This Bulletin will explain this test and provide the CCRA's position on various exceptions to the direct use test.
Question 2.2
Can you provide examples of where a taxpayer can structure its transactions to meet the direct use test?
CCRA Response
A person owns 1,000 shares of a TSX-listed corporation. The individual also owns a condominium for personal use that was financed with borrowed money. In this case, the borrowed money was used directly to acquire the condominium. This person can sell the person’s 1,000 shares, use the proceeds from the sale of those shares for any purpose, including repayment of the borrowed money used to acquire the person’s condominium, and then take out another loan to acquire 1,000 shares of the same corporation. At that point, the additional borrowed money would then have been used directly to acquire 1,000 shares.
Question 2.3
It has been stated that taxpayers can use a technique called cash damming to ensure that borrowed money is used only for eligible purposes. Can you confirm whether this technique is acceptable?
CCRA Response
Yes, this technique is acceptable. It allows a distinction to be made between funds borrowed and funds from other sources (e.g. funds from operations). This allows taxpayers to establish the precise use of the borrowed money. This is how this type of transaction is usually done:
A corporation opens two accounts in its financial institution. The only deposits to Account A are those arising from borrowed money and all other deposits (arising from transactions, etc., and not related to previously borrowed money) are made to Account B. The corporation ensures that all payments from Account A are for expenses that clearly meet the applicable conditions for interest deductibility. If some of the expenses paid from Account B were paid with borrowed money, the interest on that borrowing would not be deductible. Although some of the corporation's expenses are for purposes not otherwise eligible for interest deductibility, the borrowed money is used for specific eligible purposes and the taxpayer has clearly demonstrated those purposes.
Question 2.4
In your presentation last year, in the situation of a non-interest bearing debt issued at a discount, it was stated that the amount of the discount cannot be deducted when the debt is paid on the due date for taxpayers who do not carry on a money lending business. Is this still the case?
CCRA Response
Where there is no stipulated interest payable, the provisions of subsection 16(1) may apply to such contracts with the result that an amount is deemed to be interest on a debt obligation to the investor and the issuer. Since subsection 16(1) refers to an amount under a contract rather than a payment, interest is deductible based on the amount paid or payable. It should be noted, however, that such contracts with maturities of more than one year are considered to provide for both simple interest (deductible on the basis of the amount paid or payable) and compound interest (deductible only on the basis of the amount paid).
Michelle Desrosiers
October 10, 2003
2003-003564