As you sit down to prepare your 2012 tax return over the weeks ahead, you may wish to pay particular attention to rules governing the deductibility of interest, especially if you are a student or have kids attending post-secondary education.
Under the student loan interest rule, which was introduced for 1998 and subsequent tax years, you can claim a non-refundable tax credit for the amount of interest paid on certain student loans. Note that while only the student can claim the student loan interest credit, the interest on the loan itself can be paid either by the student or by someone related to the student, such as a parent.
If the student has no tax payable for the year, either because they had minimal income or had sufficient other credits to reduce tax payable to zero, it makes no sense to claim the interest credit and instead, the student can carry the interest paid forward and claim it on any tax return in the following five years.
So which student loans qualify for the interest tax credit?
The Income Tax Act is very specific and states that only loans received under the Canada Student Loans Act, the Canada Student Financial Assistance Act or a similar provincial or territorial government law qualify. This condition can be fatal to determining your eligibility for the tax credit as two sisters recently found out in Tax Court in a case decided earlier this year.
The issue in the case was whether interest paid by each of the sisters on their student loans in 2010 was eligible for the student loan tax credit. The students, who were represented in court by their mother, had borrowed money under a special student line of credit offered by a bank since they were previously turned down for student loans offered under the government's student loan program because their parents' income was too high.
The program, referred to as the "Student Line of Credit," allowed a student to borrow up to $45,000 for post-secondary education. Promotional material issued by the bank stated that the interest rate on the line of credit was lower than the rate on student loans and that no principal repayments were required until one year after graduation.
Unfortunately, the law in this area is quite clear. As the judge explained, "The tax relief for interest on student loans in...the (Income Tax Act) is designed to apply to loans that are provided under legislation aimed at providing financial assistance to students at the post-secondary level."
Since the loans provided to the sisters were not eligible under any government program, the interest paid was not eligible for the non-refundable tax credit.
While Mom tried to argue that the loans "must be sanctioned under some legislation because the bank is a federally regulated institution," this argument failed since the only federal statutes that qualify are the Canada Student Loans Act and the Canada Student Financial Assistance Act.