2 August 1990 Income Tax Severed Letter ACC9347 - Interest Deductibility

24(10                         5-901161
                                        M. Séguin
                                        613 957-8953
Attention:  19(1)                       C-9347

August 2, 1990

Dear Sirs:

Re: Interest deductibility

This is in reply to your letter of May 29, 1990 concerning the deductibility of interest on borrowed funds where the borrower injects the proceeds in a corporation which will treat the funds as an increase instated capital of the shares already owned by the borrower.

As mentioned in paragraph 3(c) of Interpretation Bulletin IT-445 , the Department's general position is 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.

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.

A shareholder who transfers borrowed funds to a corporation as an increase in the stated capital of his shares would not directly acquire any property. Therefore, in accordance with the above quoted comments, the interest expense would not be deductible.

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 Director Bilingual Services and Resource Industries Division Rulings Directorate