Is Your Interest Tax Deductible?

If you are going to have debt, one should always ask the question whether the interest, with respect to the debt, will be tax deductible. This is a simple step that will reduce the cost of your debt. Tax planning often allows you to accomplish interest deductibility, especially if you are a business owner.

The general rule of thumb for interest deductibility is that the direct use of the borrowed money must be for the purpose of earning income from a business or property. However, the onus is on the taxpayer to trace or link the borrowed money to a specific eligible use.

Below are two examples of court cases where tax interest deduction claims were challenged:

In tax court case—The Queen v. Singleton 2001 SCC 61, 2001 DTC 5533, Mr. Singleton, a business owner, stripped funds from his business to buy his primary residence. He then mortgaged his clear title home and injected the cash back into his business. The Supreme Court accepted his position that the interest was deductible because of the direct use test. (I.e. the direct use of the borrowing was to fund his business, even though the circling of the cash resulted in him acquiring a home for personal use).

In another tax case—Stewart v. The Queen, 2002 SCC 46, 2002 DTC 6989—the Canada Revenue Agency (“CRA”) tried to disallow interest expense on the basis that there was no reasonable expectation of profit (“REOP”). Taxpayer’s 100% financed rental property produced rental losses year after year due to interest expense. Even though the taxpayer won this case, one should be mindful about the CRA imposing a REOP test on your borrowed funds.

“Structuring your debt to ensure the interest expense is tax deductible should absolutely form part of your tax planning strategy”. – Sanjay Naicker, Managing Partner

Here are a few quick tips:

  1. If you are buying a personal use property, like a new home, or your mortgage is coming up for renewal, consideration should be given to planning steps similar to Mr. Singleton to ensure the interest is tax deductible.
  1. When making an investment with borrowed funds, analyze the reasonable expectation of profit test. Take steps to ensure positive earnings are reported to pass any scrutiny from the CRA.
  1. Certain interest payments are not deductible, such as the interest paid to the CRA. Your ongoing approach to tax planning should include a process of identifying these small items to ensure your deductions are maximized.

What to do next?

If you have any questions on how to ensure the interest on your debt is tax deductible and how to properly plan for this, please drop us a line:  //  587.320.3940

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