SSH/BDC-1 A. Jane (613) 957-2126
October 8, 1986
Re: Request for Technical Interpretation
This is in reply to your letter of July 23, 1986 wherein you request our opinion as to the interpretation of paragraphs 20(1)(c) and 20(1)(bb) of the Income Tax Act (the "Act") and, more particularly, as to their application in the situation outlined below.
SITUATION ENVISAGED
Pursuant to the terms of a written agreement (the "Agreement"), an individual or corporation (hereinafter referred as the "Investor") shall appoint a corporation (hereinafter referred to as the "Agent") as its agent to invest in equity and money market mutual funds in the United States and, for those purposes, to borrow money on a non-recourse basis on behalf of the Investor up to but not exceeding twice the amount invested directly by the Investor at a rate of interest not to exceed a specified amount, to engage an investment advisor in the United States (the "Investment Counsel") and to administer the investments.
More particularly, the Agent shall be authorized as agent for the Investor, inter alia, to pool the Investor's investment together with investments of others, to use the pooled investment to acquire mutual fund shares in particular mutual funds in the United States (such shares hereinafter referred to as the "Securities"), to receive dividends and interest on, and proceeds of disposition arising in respect of, the Securities. The Agent will be authorized further to pay the costs of Investment Counsel on behalf of the Investor out of the fee charged by the Agent to the Investors and the Agent itself will be entitled to a service fee, being the difference between the fee charged to the Investors and the costs of the Investment Counsel.
OPINIONS SOUGHT
You request our opinion as to the deductibility, pursuant to the provisions of paragraph 20(1)(c) of the Act, of the interest expense to be incurred by the Investor in the situation outlined above, as well as our opinion as to the deductibility, pursuant to paragraph 20(1)(bb) of the Act, of the fee to be paid to the Investment Counsel and the service fee to be paid to the Agent.
Since a proposed transaction is involved, we consider it inappropriate to deal specifically with your request other than by way of an advance income tax ruling. In this regard, we refer you to the comments in Information Circular 70-6R. We are prepared to offer the following general comments.
COMMENTS
In our opinion, interest expense incurred by an investor in purchasing securities including mutual funds would not be a deductible expense under paragraph 20(l)(c) of the Act where the potential return to the investor excluding capital gains does not exceed his borrowing costs. It is our opinion that interest is deductible under paragraph 20(1)(c) of the Act only if there is a likelihood of a net income yield from the investment of a taxpayer after all deductions including interest expense. Where there is no likelihood of a net income yield from the investment, it is our opinion that the interest would only be deductible to the extent of the investment income earned. Finally, whether or not there is a likelihood of a net income yield is, of course, a question of fact in each particular case.
The deduction by virtue of paragraph 20(1)(bb) of the Act applies only to fees paid on account of capital. Thus, where the prerequisites set out in paragraph 20(1)(bb) are met, a deduction under that provision is appropriate where the securities are acquired as capital property and the fees are paid in respect of such property.
We confirm that fees that otherwise meet the requirements of paragraph 20(1)(bb) are not disallowed as a deduction merely because the formula for calculating such fees are based on the amount of capital invested and on increases in the value of the securities.
Finally, we note that the shares and securities being managed must be owned by the taxpayer seeking the deduction. In the Department's view, both legal and beneficial ownership must be with the taxpayer. Although it is not necessary that the shares and securities be in the custody of the taxpayer, the taxpayer must be the registered owner.
We trust this will be of assistance.
Yours truly,
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch