Borrowing to invest? The CRA just clarified the rules on interest deductibility
Earlier this month, the Canada Revenue Agency updated its comprehensive folio on the topic of interest deductibility , and while most of the changes aren’t of interest to the average taxpayer, the folio has been revised to add a reference to more recent case law on the meaning of the phrase, “for the purpose of earning income from a business or property.”
As a refresher, under the Income Tax Act, interest expense is considered to be a capital expense, and is not deductible unless it meets specific requirements. First, it must be an amount paid or payable under a legal obligation to pay interest, and the amount must be reasonable. In addition, when funds are borrowed, the money must have been acquired for the purpose of earning income from a business or earning income from property (i.e. investment income.)
The updated folio confirmed that the phrase “for the purpose of earning income from a business or property” does not include a reasonable expectation of capital gains, referencing a 2017 Tax Court decision. This concept has caused some confusion among investors who regularly ask about writing off interest expense to buy investments that don’t generate income, and are primarily held to earn a capital gain over time.
Fortunately, the CRA takes a lenient approach, depending on the facts. For example, where funds are borrowed to make an investment that carries a stated interest or dividend rate, the income-earning test will be met and interest will generally be deductible “absent a sham or window dressing or similar vitiating circumstance.” It’s important to note that the rate or amount of interest or income earned on the investment need not be higher than the interest expense to entitle you to write off the
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