Evelyn Jacks: Part 2 – Deducting Interest in Special Circumstances

According to Statistics Canada there were 2.3 million businesses in Canada as of June 2009, with 57% of all business establishments located in Ontario and Quebec. 

About 25% produce goods, while 75% provide services. Most of these firms count on financing to grow. When will interest be deductible, particularly during tough times? It’s important for investors to discuss the rules with their tax advisors to be sure. Here are four to be aware of:   

• Limitation on Interest Deduction on Purchase of Undeveloped Land: The deduction for interest and property taxes on land is limited to the net income from the land. These limitations do not apply to land used in the course of business other than land development. Interest and property taxes not deductible may be added to the cost base of the land.
   
• Interest Paid on Capital Property that is No Longer Owned: When a taxpayer borrows money to acquire a capital property for the purposes of earning income from that property and subsequently disposes of the property for an amount less than the amount borrowed to acquire the property, it is deemed that the taxpayer continues to use the property for the purpose of earning income from property. In other words, if the proceeds of the sale are used to pay back the money borrowed, then the interest payable on any outstanding balance will continue to be deductible.

• Borrowing to Honour a Guarantee. Interest costs in these cases are generally not deductible unless it can be shown that the transaction will increase the potential for dividends to be received. If the taxpayer receives consideration of some kind for fair market value, such amounts are a source of income and therefore any interest expense incurred to earn it will be deductible.
   
• Leveraged Buy-outs. Interest on money borrowed to acquire common shares will be deductible. CRA comments further in its IT 533 on this subject, by saying there is no arm's length requirement in this case.

LAST TIME: Evelyn Jacks: Part 1 – When Interest Is Tax Deductible

Evelyn Jacks is President of Knowledge Bureau and author of 50 books on tax and personal wealth management. She is also the founder and director of the Distinguished Advisor Conference (DAC). The theme of this year’s three day think tank in Ojai, CA Nov 10-13 will be “Back to the Future – Collaborative Wealth Management.”  Follow Evelyn on Twitter at @EvelynJacks.