Evelyn Jacks: Part 1 – When Interest Is Tax Deductible

Did you know that small firms in the business sector create proportionately more jobs than large firms, especially in the early years of development?

This pattern, however, disappears once the age of the firm is taken into account – older firms contribute more to employment growth[1]. For these reasons, lending to help firms grow is important to the economy. Tax efficient borrowing reduces the costs. 

CRA has set out its current interpretations on interest deductibility in its IT-533. Following are some audit-proofing tips business owners should know and discuss with their financial professionals: 

• Tracing / linking: The onus is on the taxpayer to trace funds to a current and eligible usage. Taxpayers must demonstrate that aggregate eligible expenditures from co-mingled accounts, for example, exceed the amount borrowed and deposited to that account.
   
• Income-producing accounts: CRA accepts that the use of borrowed money can be for an ancillary rather than primary income-producing purpose. This will be determined as a question of fact, so make sure you make detailed notes to explain reasons for borrowing.
   
• Borrowing to pay dividends. The interest expense amounts will be deductible.
   
• Borrowing to contribute capital. Interest may be deductible if the borrowed funds can be linked to an income-producing purpose (i.e. the issuing of dividends).
   
• Borrowing to make loans to employees and shareholders. Interest will be deductible if there is a reasonable expectation of income. This comes from the effort of the employee and such loans would be therefore viewed as a form of remuneration.

NEXT TIME: Evelyn Jacks: Part 2 – Deducting Interest in Special Circumstances 

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.