Watch for the dividend wrinkle when writing off interest on investment loan
Google has never paid a dividend.
But on Thursday, financial website TheStreet cited a research note from SunTrust's Robert Peck estimating Google to have about US$10 billion in "hidden assets," which could lead to the company paying a dividend at some point in the future.
A common question that arises is whether you can write off interest on an investment loan to buy shares, even if those shares, like Google, don't pay any dividends.
After all, it's common for small, medium or even large corporations not to pay a dividend in their early years for various reasons, such as the lack of initial profitability, cash reinvestment needed for the business or simply for tax reasons. Similarly, a mining or oil company in the exploration stage may not pay dividends for years to come. And what about mutual funds that don't pay out income and only distribute capital gains?
The Tax Act says that if you've borrowed money for the purpose of earning business or investment income, the interest paid on the loan is generally tax deductible. But what if there simply isn't any income being paid out?
The Canada Revenue Agency has a longstanding administrative position, backed by Supreme Court jurisprudence, which states that - yes you can, generally, write off your interest expense on money borrowed to purchase common shares or mutual funds "on the basis that there is a reasonable expectation, at the time the shares are acquired, that the common shareholder will receive dividends."
A recent court case last year, however, put the CRA's administrative policy to the test.
In the case, the court disallowed a claim for interest expense by a taxpayer who borrowed money to purchase common shares in the family business from her husband. The court concluded that the taxpayer wasn't entitled to deduct the interest because there was no reasonable expectation of profit when she purchased the common shares, citing the fact that the corporation did not have a history of paying dividends nor did it have a formal dividend policy.
Furthermore, the company was paying its shareholders with bonuses instead of dividends. In fact, it wasn't until nearly a decade later that the taxpayer got her first taxable dividend from the company.
Last October, the CRA was asked in a roundtable discussion whether it had changed its longstanding position on the deductibility of interest on investment loans in light of this recent court decision. The CRA's response was recently published in a technical interpretation.
Fortunately, the CRA stated that the court's comments regarding interest deductibility and the lack of dividend history would not affect its longstanding administrative policy and that "the CRA will continue to allow the deduction of interest incurred on funds borrowed to acquire common shares if it considers that, at the time the shares are purchased, there is a reasonable expectation that dividends will ultimately be received on the shares."
So, if you're thinking of increasing your line of credit to buy more Google stock, you should have no trouble writing off the interest come tax time.