Interest on a Loan Used To Buy Common Shares May Not Be Deductible
Paragraph 20(1)(c) provides for a deduction against income for amounts paid or payable in respect of interest on borrowed money used for the purpose of earning income. Typically, it is taken for granted that interest relating to a purchase of common shares with dividend rights is deductible under this paragraph. However, Swirsky v. The Queen (2013 TCC 73; under appeal) has called that presumption into question. In Swirsky, though money was borrowed to purchase common shares with dividend rights, the purpose test of paragraph 20(1)(c) was not met, and the interest on the loan was not deductible.
Mr. S owned valuable shares in his family's corporation. Facing financial trouble, he undertook a Lipson-like transaction with his wife for creditor-proofing purposes. Mrs. S borrowed money to purchase Mr. S's shares at fair market value. Interest on that loan caused Mrs. S to realize losses, which were attributed back to Mr. S. (The fair market value exception to attribution in subsection 74.5(1) did not apply because the spouses used the subsection 73(1) interspousal rollover.) The deductibility of these losses was at issue. Of particular interest to the court seemed to be the fact that the family corporation did not have a history of paying dividends on its shares (rather, profits of the corporation were distributed by way of bonus to Mr. S) and that neither the Ss' advisers nor Mrs. S herself explicitly and specifically expressed an income-earning purpose for these shares. It is noteworthy that dividends were paid on the shares, albeit years after the exchange between Mr. and Mrs. S.
Given these facts, the court was of the opinion that creditor proofing was the sole purpose for the sale of the shares from one spouse to another. Thus, Mrs. S's borrowing failed the purpose test requirement of paragraph 20(1)(c), and the interest was not deductible. In coming to this conclusion, the court framed its decision using the Supreme Court of Canada's test in Ludco (2001 SCC 62): "whether, considering all the circumstances, the taxpayer had a reasonable expectation of income at the time the investment was made." The details of the Swirsky decision suggest a more marked skew toward a specific taxpayer's personalized "reasonable expectations" than toward the more generalized objective reasoning usually associated with the belief that borrowing money to purchase common shares with dividend rights has an income-earning purpose. Swirsky is a cautionary tale, the lesson being that the same activity can have a different purpose depending on the circumstances of the taxpayer undertaking the activity.
For completeness, in Swirsky a deduction under paragraph 20(1)(e.1) was also in dispute and was denied because a similar purpose test is part of that provision. Additionally, the CRA raised subsection 74.5(11) and subsection 245(2) avoidance arguments that were discussed in obiter: the court stated that neither would apply, given the creditor-proofing purpose of the transaction.
Darryl R. Antel
Pitblado Law, Winnipeg