Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: Interest Deductibility - money borrowed to finance non-income producing assets
Position: General Comments
Reasons: Published position
October 11, 2002
TORONTO CENTRE TSO HEADQUARTERS Large Case Section Income Tax Rulings Audit Division Directorate G. Moore Attention: Dan Wilson 957-2747
2002-015533
Interest Deductibility - Paragraph 20(1)(c) of the Income Tax Act
We are writing in reply to your memo of July 30, 2002, regarding interest deductibility, in which you ask for our views regarding the following situation.
The taxpayer borrowed $XXXXXXXXXX from its parent at an interest rate of prime plus one-quarter. On the same date, the taxpayer reduced paid-up capital by $XXXXXXXXXX. It is your understanding that an interest deduction under paragraph 20(1)(c) of the Income Tax Act (the "Act") would otherwise be allowable; however, the taxpayer has a non-interest bearing convertible debenture from a foreign affiliate company for approximately the same amount. It is your view that since one of the assets was non-interest bearing and not an income-producing asset that a portion of the interest expense should not be disallowed.
Our Comments
Further to the telephone conversation (Darling/Wilson) regarding this matter, we confirm that it is our view that the interest issue in this particular file should not be pursued. In the situation you described, a portion of the capital being replaced by the taxpayer was being used to finance non-income producing assets, namely the non-interest bearing convertible debentures issued by an indirect wholly owned foreign subsidiary. The issue is whether the convertible debentures meet the purpose test (i.e., are held for the purpose of earning income) in paragraph 20(1)(c) of the Act. The Supreme Court (Ludco) has indicated that the purpose test is to be applied as follows: considering all the circumstances, did the taxpayer have a reasonable expectation of income at the time the investment was made (absent a sham, window dressing, or other vitiating circumstances)? We also recognize and accept the Court's remarks that the use of borrowed money for an ancillary purpose of earning income can meet the test for interest deductibility (i.e., the main or overriding purpose for the use of the borrowed money need not necessarily be to earn income). However, the finding of the purpose for the use of borrowed money will be a question of fact.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the CCRA's mainframe computer. 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. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (819) 994-2898. The severed copy will be sent to you for delivery to the client.
We trust this information is satisfactory for your purposes.
Steve Tevlin
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch