Tim Horton's RRRolls Up The Rim In Interest Deduction Win

The Federal Court of Appeal has allowed The TDL Group Co. (TDL) to deduct interest on borrowed money which was used to acquire common shares of a wholly-owned US subsidiary, reversing the Tax Court decision rendered last year. The Tax Court had denied the deduction of interest, concluding there was no reasonable expectation of TDL earning non-exempt income from the common shares acquired with the borrowed money. This decision reaffirms the generally accepted position that interest on money borrowed to acquire common shares is deductible (provided there is a possibility of earning non-exempt income, such as dividends on the shares).

TDL had borrowed $234 million indirectly from its ultimate US parent (Wendy's) on an interest-bearing basis and used the borrowing to purchase additional common shares in a wholly-owned US subsidiary (Tim's US). Tim's US lent the monies received from TDL's share subscription to Wendy's on an interest-free basis. The series of transactions resulted in the money that was advanced by Wendy's on an interest-bearing basis being returned to Wendy's as a loan on an interest-free basis.

The Court of Appeal found it relevant that the loan to Wendy's was originally intended to be on an interest bearing basis, but concerns arose under various tax rules in the US and Canada. As a result, TDL decided the loan to Wendy's would be advanced on an interest-free basis until these concerns could be addressed. The non-interest bearing loan was replaced with an interest-bearing loan seven months after the original interest-free loan was made to Wendy's.

The interest expense deduction which the CRA denied related to the interest paid by TDL during the seven month period during which the interest-free loan to Wendy's was outstanding. The Minister had disallowed the interest deduction pursuant to subparagraph 20(1)(c)(i) of the Income Tax Act (Canada) (the Tax Act), on the basis that the money borrowed by TDL was not used for the purpose of earning income from a business or property. The CRA had allowed TDL to claim an interest expense deduction for interest it paid after the debt owing by Wendy's became interest bearing.

The Federal Court of Appeal has confirmed that the appropriate time to determine a taxpayer's "purpose" when the borrowed funds are used to subscribe for common shares is "at the time the investment was made." This test was set out by the Supreme Court of Canada in Ludco Enterprises Ltd. v. Canada, 2001 SCC 62.

Since...