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Interest Deductibility: Returns of Capital

In an April 20, 2018 Tax Court of Canada case, at issue was whether the taxpayer could deduct interest incurred in 2013, 2014, and 2015 related to $300,000 borrowed in 2007 to purchase mutual funds. From 2007–2015, the taxpayer received a return of capital* from the funds, totalling $196,850 over the period. The taxpayer used some proceeds to reduce the loan principal, but the majority was used for personal purposes.

Taxpayer loses
The Court examined whether there was a sufficiently direct link between the borrowed money and its current use in respect of gaining or producing income from the investments.

As much of the returned capital was used for personal purposes, there was no longer a direct link to the income earning purpose. The Court upheld CRA’s denial of interest expense.

Action Item: Where funds are borrowed to invest, one may need to track any return of capital which is not reinvested to determine interest deductibility.

*A return of capital is essentially a return of the taxpayer’s original investment.