26 May 2005 Roundtable, 2005-0126051C6 - S. 138(5)(b) Interest Deductibility

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Application of subsection 138(5)(b) in several scenarios.

Position: See document

Reasons: See document

2005-0126051C6

CLHIA Conference - May 26, 2005

Question 8

Interest Deductibility - Paragraph 138(5)(b):

The provisions of paragraph 138(5)(b) apply in lieu of those in paragraph 20(1)(c) to determine the deductibility of interest in the case of a non-resident insurer or a life insurer resident in Canada that carries on any of its insurance business in a country other than Canada. While the concepts appear to be similar, the application of the provision in various fact situations may be problematic. Two examples are provided below.

Scenario 1

A life insurer resident in Canada that carries on its insurance business in Canada and in another country borrows $100 and uses the funds to acquire Property A. Property A appreciates in value and is sold by the insurer for $150. The insurer reinvests $100 of the sale proceeds in Property B. Each of Property A and Property B is a designated insurance property of the insurer throughout the period that it is owned by the insurer. The remaining $50 of the sale proceeds are invested in a property that is not a designated insurance property.

Questions

Would the CRA confirm that subparagraph 138(5)(b)(i) of the Act, will apply to allow the amount of the interest payable on the $100 borrowing to continue to be deductible following the acquisition of Property B?

Agency's Response

The CRA will follow the positions in paragraph 18 of Interpretation Bulletin IT-533 "Interest Deductibility and Related Issues" in determining the current use of borrowed money, for the purposes of subparagraph 138(5)(b)(i) of the Act. Accordingly, provided the taxpayer can trace the $100 of borrowed money to a current use which is the acquisition of designated insurance property, the interest payable on the $100 will continue to be deductible, provided it otherwise satisfies the interest deductibility requirements under paragraph 20(1)(c) of the Act.

Scenario 2

A life insurer resident in Canada that carries on its insurance business in Canada and in another country acquires Property C and Property D for $100 each and, in each case, incurs a debt of $100 to the seller for the purchase price. The life insurer then borrows $100 from a bank and uses the funds to satisfy the debt to the seller of Property C. The life insurer sells Property D for $100 and uses the sale proceeds to acquire Property E. Each of Property C, Property D and Property E is a designated insurance property of the insurer throughout the period that it is owned by the insurer.

Questions

(a) Would the CRA confirm that, for the purposes of subparagraph 138(5)(b)(ii) of the Act, the debt owing to the bank that was used to satisfy the debt to the seller of Property C will be considered to be an amount payable for Property C?

(b) Would the CRA confirm that, for the purposes of subparagraph 138(5)(b)(ii) of the Act, the debt owing to the seller of Property D will be considered to be an amount payable for Property E?

(c) If the CRA is unable to confirm either of these propositions, will the Department of Finance recommend an amendment to subparagraph 138(5)(b)(ii) of the Act to permit interest deductibility in these circumstances?

Agency's Response

(a) In the example, the borrowed money was used to repay an amount payable for designated insurance property and not to acquire designated insurance property. For the purposes of paragraph 20(1)(c) of the Act, where borrowed money is used to repay an amount payable for property acquired for the purpose of gaining or producing income from the property or from a business, subsection 20(3) of the Act, subject to subsection 20.1(6) of the Act, will deem the borrowed money to have been used to acquire the property in respect of which the amount was payable. Subsection 20(3) of the Act, applies for the purpose of a number of specific provision of the Act but does not apply for the purpose of subsection 138(5) of the Act. Accordingly, it is our view that the borrowed money in the example would not be an amount payable for Property C, for the purposes of subparagraph 138(5)(b)(ii) of the Act.

(b) Consistent with the CRA's comments in paragraph 27, of Interpretation Bulletin IT-533 "Interest Deductibility and Related Issues", provided the amount payable by the insurer to the vendor of Property D in respect of the taxpayer's acquisition of Property D can be traced to a current use which is the acquisition of Property E, then the amount payable by the insurer to the vendor of Property D will be considered to be an amount payable for Property E. Since, Property E is a designated insurance property, it is our general view that subparagraph 138(5)(b)(ii) of the Act will continue to apply to allow for the deductibility of any interest on the amount payable by the taxpayer to the vendor of Property D. The conditions in paragraph 20(1)(c) must also be satisfied before any deduction may be claimed in respect of interest.

(c) Finance's reply.