Home -> Personal Tax -> Stocks, Bonds etc. -> Interest and Other Investment Expenses / Non-Deductible Expenses
Interest and Other Investment Expenses
Income Tax Act S. 20(1)(c), 20(1)(d), 20(3)
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 (i.e., paid or accrued), 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.
Deductible interest expense can include interest on funds borrowed by the taxpayer from a joint line of credit held with the spouse, if the funds are used to purchase investments owned by the taxpayer (not owned jointly with the spouse) and the taxpayer makes the payments of principal and interest. If the spouse makes the payments, attribution rules will apply, and the interest expense may not be deductible. For more information on this see Technical Interpretation 2009-0317041E5 - Spousal attribution re joint line of credit.
If the joint line of credit is used to purchase investments in a joint investment account and as an example each spouse has a 50% share of the investments based on their contributions to the account, then each spouse should be paying 50% of the payments. Each spouse would deduct 50% of the interest expense and would include 50% of the investment income in their income. This would also apply to a joint investment account which uses margin to purchase the investments.
See our article on Attribution Rules and Investments Held Jointly with Spouse.
If the interest is paid to a non-resident, it will still be tax deductible, but see interest expense paid to non-residents regarding withholding tax that should be deducted from the payment.
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.
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.
S. 20(1)(d) of the Income Tax Act allows the deduction of compound interest - that is, "an amount paid in the year pursuant to a legal obligation to pay interest on an amount that would be deductible under paragraph (c) if it were paid in the year or payable in respect of the year".
If the interest on debt incurred to pay interest exists because a second loan was taken out to pay the interest, this interest is still deductible. See Technical Interpretation 2007-0254941E5 Interest Deductibility - Second Loan.
You must be able to trace borrowed money directly to the purchase of the income-producing investments by the taxpayer. It is important to keep a clear paper trail (or electronic document trail) of the use of borrowed money. See Disappearing Source Rules below for what happens when a leveraged investment is sold.
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.
If funds have been borrowed to purchase mutual funds or exchange traded funds (ETFs) and there are subsequent return on capital payments from the mutual fund, these amounts must be used to pay down the borrowed funds, because the interest will no longer be deductible. This was brought to light in a Tax Court Case, Van Steenis v. The Queen, 2018 TCC 78, where Van Steenis had borrowed $300,000, and over a period of 9 years received a total of $196,850 for return of capital. Van Steenis used most of the return of capital for personal purposes, instead of paying down the debt. The Tax Court ruled that there is no longer a direct link between the borrowed funds and the investment in mutual funds. Had Van Steenis paid down the debt or reinvested the return of capital amounts in other investments for which interest expense would be deductible, he would not have had a problem. Jamie Golombek of the Financial Post summarized this Tax Court case in a May 2018 article.
When you have borrowed to purchase an investment, this is called a "leveraged" investment. When the investment is purchased, the amount borrowed for the purchase should be repaid. If it is not repaid, the interest on the purchase amount will no longer be deductible, unless the funds are reinvested to earn income.
Income Tax Act s. 20.1(1)
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, except in example 3 below. See CRA's Folio S3-F6-C1 on this topic - link at bottom.1. The shares are sold for $6,000, and the proceeds are used to buy another income-producing property.
- The interest on the entire $10,000 will still be deductible until the loan is repaid, or the 2nd income-producing property is sold.
2. The shares are sold for $6,000, and the proceeds are used to buy personal property.
- The interest on $6,000 is no longer deductible, but the interest on $4,000 is still deductible until the loan is repaid.
3. The shares are sold for $6,000, and the proceeds are used to pay down the debt.
- The interest on the remaining $4,000 of debt is still deductible until the loan is repaid.
4. The shares have become worthless due to the bankruptcy of the corporation. See Worthless Shares or Debt.
- The interest on the entire $10,000 of debt is still deductible until the loan is repaid.
Note that the legislation refers to an amount "received as consideration" for the disposal of the investment. This would indicate that if some of the amount received in exchange for the shares is characterized as a dividend, it would still be "consideration" received for the shares. If it is not used to pay down the debt, then that portion of the debt would not be deductible.
Tax Tip: Keep good records of all transactions!
Interest and other deductible carrying charges are claimed as a deduction from income on line 22100 (was line 221) of the personal income tax return, after completion of Schedule 4 (federal). These amounts are not used in the calculation of adjusted cost basis for your investments, so are not used in the calculation of capital gains or losses on investments.
In the Canadian Tax Calculator, interest expense would be entered in "Other expenses".
Deductible carrying charges or investment expenses include the following as well as interest, if the cost has been incurred in order to earn income from your investments:
The above amounts would be included in "Other deductions" in the Detailed Canadian Tax Calculators.
Non-deductible interest, carrying charges and investment expenses include
Bernacchi v. The Queen 2010 TCC 306 - joint line of credit, legal obligation to pay
Brown v. The Queen 2020 TCC 84 - interest on money borrowed to repay previous loans: For the purposes of paragraph 20(1)(c), if a taxpayer uses borrowed money to repay money previously borrowed, the borrowed money is deemed to be used for the same purpose as the previously borrowed money: see subsection 20(3).
Folio S3-F6-C1 Interest Deductibility - see paragraph 1.41 Disappearing source rules
IT-238R2, Fees Paid to Investment Counsel - Archived
IT-99R5, Legal and Accounting Fees - Archived
IT-533 Interest deductibility and related issues - cancelled
Revised: January 20, 2024
Copyright © 2002 Boat Harbour Investments Ltd. All Rights Reserved. See Reproduction of information from TaxTips.ca