{"id":295,"date":"2012-12-10T17:25:50","date_gmt":"2012-12-10T17:25:50","guid":{"rendered":"https:\/\/thor.ca\/\/blog\/?p=295"},"modified":"2025-02-12T13:31:03","modified_gmt":"2025-02-12T21:31:03","slug":"its-how-you-use-it-that-matters","status":"publish","type":"post","link":"https:\/\/www.thor.ca\/blog\/2012\/12\/its-how-you-use-it-that-matters\/","title":{"rendered":"It\u2019s How You Use it That Matters"},"content":{"rendered":"

In a recent article in a golfing magazine that I read, a leading light in the golf instruction world started off an article with the observation \u201cGolf is a hard game.\u201d (Hank Haney, \u201cGolf Digest,\u201d January 2013.) If you\u2019re a non-golfer this may seem counter intuitive. After all, the ball isn\u2019t moving before you hit it, so what\u2019s so hard about that? Any golfer will answer \u201cA lot!\u201d It would take a book to list the ways golf can be an almost impossible game to play well. In fact, one of the great dangers facing any serious golfer is the temptation to over analyze the mechanical aspects of the game forgetting that the object of the exercise is hitting <\/em>the ball, not thinking <\/em>about hitting it. In an indirect sort of way this brings me around to the subject of today\u2019s post, interest deductibility.<\/p>\n

In a recent technical interpretation (TI 2012-0446741E5), the CRA was asked to consider whether interest was deductible by an individual who, owning shares in a corporation, borrows money to invest in a new class of its dividend paying preferred shares. On the surface and if this was all there was to it, there would be no question about the deductibility of the interest paid on that borrowing. Paragraph 20(1)(c) of the tax legislation allows the deduction of interest paid on money borrowed if the borrowed money is \u201cused for the purpose of earning income from\u2026 (inter alia) property.\u201d In a series of cases culminating in the Singleton <\/em>decision (SCC 2001), the Supreme Court has held that interest is deductible if the direct use <\/em>of the borrowed money is the acquisition of income-producing property. Since dividend paying shares meet this test, interest paid on money borrowed to purchase the shares is deductible. But there is more to the CRA example than a borrowing to fund a straightforward share purchase.<\/p>\n

Sometime after the shareholder acquires the preferred shares (the implication is that the time is immediately after the shares are issued), the corporation reduces the capital of those shares to a nominal amount. The shareholder uses the amount paid on the redemption for non-income producing purposes. May the shareholder continue to deduct the interest on the loan? The CRA suggests not. As stated in the TI: \u201c\u2026as the capital is immediately returned to the shareholder, the borrowed money is not used in the corporation\u2019s business. Interest on the loan would not be deductible since the \u201ccurrent use\u201d of the borrowed funds is personal rather than income-producing.\u201d I think this misapplies the \u201cuse\u201d test in 20(1)(c).<\/p>\n

As the many cases on interest deductibility point out (as well as the CRA itself in Interpretation Bulletin IT-533), the primary test for interest deductibility is the direct use<\/em> of the borrowed funds. Here, the direct use remains constant \u2013 the ownership of the dividend paying preferred shares. The reduction in the paid-up capital of those shares is not a disposition of them for tax purposes, so the direct use test continues to be met. The CRA seems to have confused a secondary test for interest deductibility, the so-called indirect use test.<\/p>\n

The indirect use test will allow the deduction of the interest where the primary test is not met, but the borrowed money can be traced to an indirect eligible use. A common example is money borrowed by a shareholder and lent interest-free to the corporation. Because the loan to the corporation does not bear interest, that loan does not meet the direct use test. However, if the corporation uses the money borrowed from the shareholder to earn income, the indirect test is met and the shareholder may deduct the interest paid on the initial borrowing. This seems to be CRA\u2019s approach to the question discussed in the TI. But in the circumstances described there, it is not necessary to go to the indirect use test because the shareholder continues to meet the direct use requirement.<\/p>\n

There may be circumstances in which a shareholder ostensibly meets the direct use test when in fact the prospect of dividends being paid on the shares is remote. The CRA has tools to deal with this. Paragraph 20(1)(c)itself has been interpreted to require a \u201creasonable expectation of income\u201d test which might apply in that event (Ludmer, <\/em>SCC 2001)<\/em>. Or, there is always the GAAR if the avoidance involved abuses the object and spirit of the interest deductibility provisions. Instead of referring to these, the TI seems to me to confuse the indirect and direct tests for interest deductibility. To return the golfing metaphor, I think CRA has focused on the tax mechanics (the possibility of improper avoidance) instead of applying the straightforward rule that clearly applies here (the direct use test). Indeed, it is a hard game.<\/p>\n

<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

In a recent article in a golfing magazine that I read, a leading light in the golf instruction world started off an article with the observation \u201cGolf is a hard game.\u201d (Hank Haney, \u201cGolf Digest,\u201d January 2013.) If you\u2019re a…<\/p>\n","protected":false},"author":10,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[52],"tags":[],"class_list":["post-295","post","type-post","status-publish","format-standard","hentry","category-tax-blog-general"],"_links":{"self":[{"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/posts\/295","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/users\/10"}],"replies":[{"embeddable":true,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/comments?post=295"}],"version-history":[{"count":1,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/posts\/295\/revisions"}],"predecessor-version":[{"id":2829,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/posts\/295\/revisions\/2829"}],"wp:attachment":[{"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/media?parent=295"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/categories?post=295"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.thor.ca\/blog\/wp-json\/wp\/v2\/tags?post=295"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}