Income Tax Act S. 20(1)(c)
Generally, in order for interest to be deductible under ITA s. 20(1)(c), the interest must be payable in the year or in respect of the year, pursuant to a legal obligation to pay interest on:
The wording of s. 20(1)(c), "payable in the year or in respect of the year", means that the taxpayer can deduct the interest on the cash basis or the accrual basis. See Accrual Basis vs Cash Basis of Accounting.
The interest expense must not exceed the lesser of the actual amount and a reasonable amount. The information below is regarding interest expense on money borrowed for the purpose of earning income from property (i.e., investments).
You can deduct interest and carrying charges incurred to earn income from securities, bonds and other Canadian or foreign investments, if they are earning investment income. The requirement of earning income generally means that the investments should be paying interest or dividends. If an investment will never earn anything except capital gains, then the interest expense is not deductible. If an investment such as common shares is not currently paying dividends, Canada Revenue Agency (CRA) will still normally allow the deduction of interest expense, if the shareholder has a reasonable expectation of receiving dividends at some time in the future. However, if a corporation has a stated policy that it will not pay dividends, then interest on money borrowed to purchase these shares will not be tax deductible. Some corporations may not pay dividends because they prefer to reinvest earnings in the company, or repurchase their own shares, which would theoretically raise the market value of the shares. Therefore, the shareholders would have capital gains instead of dividends.
In a 2013 Tax Court Case, Swirsky v. The Queen, Ms. Swirsky was denied an interest deduction because there was no evidence that, at the time the shares were purchased, she believed or expected that dividends would be paid on the shares in the future. At the time, there was no history of the company paying any dividends. This case was about a purchase of privately held shares, so is different from a purchase of publicly traded shares, but the same logic could certainly be applied to interest expense on a purchase of publicly traded shares. If the company has no history of paying dividends, do you have a reasonable expectation that dividends will be paid in the future? It is probably best to avoid using borrowed money to purchase these shares.
Deductible interest expense could include mortgage, loan or line of credit interest, margin interest charged on your brokerage account, or interest paid on Canada Savings Bonds (CSB) payroll savings programs, as long as the interest was incurred to earn investment income.
If the interest is paid to a non-resident, it will still be tax deductible (but, see interest expense paid to non-residents).
Where the interest expense exceeds the income from the investment, the interest expense will normally still be tax deductible. See Technical Interpretation 2012-0443771E5 (pdf) re interest deductibility.
You must be able to trace borrowed money directly to the purchase of the income-producing investments. It is important to keep a clear paper trail of the use of borrowed money.
Borrowing money to purchase securities such as stocks and bonds is one of the factors that is considered by Canada Revenue Agency in determining whether the taxpayer's gains and losses from the sale of securities are to be treated as income or capital. See our article on the tax treatment of investments for more information on this.
Interest expense is entered in “Carrying charges and interest expenses” on Schedule 4, which then goes to line 221 of the personal income tax return. In the Canadian Tax Calculator, interest expense would be entered in "Other expenses".
If the interest expense exceeds all other income for the year, this becomes a non-capital loss, which can be carried back to previous tax years, or forward to future tax years.
Interest may still be deductible when the securities purchased with the borrowed money are no longer owned. Let's use an example of a taxpayer who uses $10,000 of borrowed money to purchase shares in a corporation. The shares are subsequently sold at a loss, with the entire debt still outstanding. See CRA's Folio S3-F6-C1 on this topic.
Tax Tip: Keep good records of all transactions!
The above amounts would be included in "Other deductions" in the Detailed Canadian Tax Calculators.
Non-deductible interest, carrying charges and investment expenses include
Revised: November 28, 2016
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