| 19(1) | File No. 5-8100 |
| D. Hartman | |
| (613) 957-2120 |
June 9, 1989
Dear Sirs:
Re: Paragraph 20(1)(c) of the Income Tax Act (Canada) (the "Act)
We are writing in reply to your letter of March 30, 1989, wherein you submitted a request for a technical interpretation relating to paragraph 20(1)(c) of the Act.
In your letter you describe a situation in which a company redeemed its special shares which had a high fair market value and a low stated capital. In exchange for the shares the company issued a non-interest bearing demand note to the shareholder. The principal amount of the note grossly exceeded the aggregate of the stated capital of the shares and the accumulated profits of the corporation at that time. The corporation now wishes to refinance the note by borrowing funds from a financial institution or by having the sole common shareholder of the corporation borrow funds and subscribe for additional common shares of the corporation.
The situation you describe in your letter appears to portray an actual fact situation. Assurances as to the consequences of specific contemplated transactions can only be given in response to a request for an advance income tax ruling.
Where a taxpayer borrows funds to repay a non-interest bearing note that was issued on the redemption of preferred shares, interest on such money borrowed would only be deductible to the extent that it would have been otherwise deductible, if such borrowings had occurred at the time of the redemption to fund same. Interest would be deductible on the redemption of shares to the extent the borrowed money is used to return capital or distribute accumulated profits in the form of a dividend or a deemed dividend.
Our position on the deductibility of interest with respect to moneys borrowed to purchase common shares was stated at the 1981 annual tax conference. Normally the Department considers interest costs in respect of funds borrowed to purchase common shares to be deductible on the basis that the potential return to the common shareholder may exceed his borrowing cost. It is conceivable that in certain fact situations it would be quite unreasonable to expect a potential return in excess of the borrowing costs related to such shares. We do not have any guidelines that might be used to isolate such situations and feel each situation must be dealt with on the basis of the facts involved.
Yours truly,
for Director Reorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch