Rates ripe for try at leveraged investing

National Post

2010-01-23



With interest rates at historic lows, borrowing to invest is now cheaper than ever. Of course, your net cost can be reduced even further if you can deduct the interest paid from your income at tax time.

Under the Income Tax Act, you can deduct interest for the purpose of earning business or investment income. One of the most common questions investors ask is: What if the investment does not actually generate any income in a particular year, such as a common share that didn't pay out any dividends in 2009, or has never paid a dividend? Can you still write off the interest paid on money borrowed to purchase the investment?

A similar question arises with fixed-income investments: What if the interest rate on the bond or fixed-income security you purchased using borrowed money is lower than the interest rate on your loan or margin account? Are you limited in your interest deductibility to the amount of interest income actually received?

These issues were discussed in a Canada Revenue Agency tax memo, available electronically. "Income Tax Technical News #41" was released by the CRA two days before Christmas. In it, the CRA answers various questions posed at a Canadian Tax Foundation conference.

The CRA was asked whether it was still following its long-standing position on interest deductibility on money borrowed to purchase shares of a corporation that either has no stated dividend policy or a policy of paying dividends "when operational circumstances permit."

In other words, to deduct interest, must the borrower point to a history of actual dividend payments by the corporation or to a policy that it will one day pay dividends in order to be able to deduct 100% of the interest paid on the borrowed money?

In responding, the CRA referred back to a 2001 Supreme Court of Canada decision that held that, absent a "sham" or "window dressing," as long as you have a reasonable expectation of income at the time the investment was made, even though the primary purpose of the investment may have been to benefit from capital appreciation, you can still rely on the purpose of income generation.

This is consistent with the CRA's opinion that "interest will neither be denied in full nor restricted to the amount of income from the investment where the income does not exceed the interest expense." The same principle would hold true for interest paid on money borrowed to purchase equity mutual funds, which rarely, or in most cases, never pay out any income distributions.