| 24(1) | File No. 5-9798 |
| C. Robb | |
| (613) 957-2744 |
19(1)
June 12, 1990
Dear Sirs:
Re: Deductibility of Interest
We are writing in response to your letter of March 16, 1990 in which you requested our views concerning the deduction of interest on a loan incurred by a shareholder for the purpose of making a contribution of capital to a corporation wholly owned by the shareholder.
Interpretation Bulletin IT-445 outlines the Department's position concerning the deductibility of interest expenses where a shareholder borrows funds and reloans those funds at less than a reasonable rate of interest or at no interest in non-arm's length circumstances. IT-445 includes, in paragraph 3(c), a statement of the Department's general position that interest expense incurred on borrowed money is generally not deductible in whole or in part when that money
...is not used to earn income directly by the borrower in his business or from a property acquired with that borrowed money. The fact that the borrower may earn income indirectly, for example through increased dividends from a corporation to whom an interest-free loan has been made, is not sufficient cause to permit the borrower to deduct interest on his liability.
A shareholder who transfers borrowed funds to a corporation as contributed surplus would not directly acquire any property. Therefore, in accordance with the above-quoted comments, the interest expense would not be deductible.
The exception in paragraph 7 of IT-445 to the general position on interest deductibility in paragraph 3 of IT-445 is specifically confined to loans of borrowed funds by a shareholder of a corporation to the corporation or its Canadian subsidiary. It is not applicable to contributions of capital.
The opinions expressed in this letter are provided in accordance with the practice described in paragraph 24 of Information Circular 70-6R.
Yours truly,
for DirectorFinancial Industries DivisionRulings Directorate