A June 14, 2019 Tax Court of Canada case (Black vs. H.M.Q., 2016-2496(IT)G) addressed deductibility of interest on funds borrowed by the taxpayer from an unrelated third party (Qco) and advanced to a corporation controlled by the taxpayer (Opco). While the facts were complex and unusual, the case decision illustrates several principles related to interest deductibility, particularly whether the borrowed funds were used for the purpose of earning income. The taxpayer argued that his loan to Opco was interest-bearing and, therefore, had been advanced to earn income. CRA challenged this argument, in part, because there was no written documentation of this loan.

alternative sources of evidence of agreements that were not formalized in written form

Taxpayer wins
The Court held that the absence of a formal written agreement between the taxpayer and Opco was not fatal to the taxpayer’s deduction claim. Other evidence, including testimony of independent directors of Opco, press releases issued by Opco, notes to Opco’s financial statements, and the minutes of an Opco audit committee meeting discussing the loan, demonstrated that the essential terms had been agreed to. Further, Opco’s need for funds was both urgent and immediate, explaining why the loan was advanced without such formal documentation.

an income-earning purpose does not require profit be expected – a counter-intuitive concept for accountants

The fact that the taxpayer never received interest on the loan, due to a deteriorating relationship with Opco and Opco’s own financial difficulties, did not change the fact that the loan was intended to bear interest, establishing an income-earning purpose for the loan. Neither the fact that the income-earning purpose was ancillary to other purposes nor the fact that interest earned from Opco was to be at the same rate as interest paid to Qco, such that there would be no profit for the taxpayer, changed the fact that one purpose of the loan was to earn interest income. Interest on the QCo loan was properly deductible.