August 2011

Pay your interest with a smile

Well, maybe not a smile... but at least with the consolation that you can use it as an income tax deduction. Read on to find out what conditions apply.

It may not seem that obvious, but when everything is factored in - mortgage, credit cards, lines of credit, car and other consumer loans - the interest paid on borrowed money adds up to a considerable slice of a household budget. Wouldn't it be nice if these costs could be deducted on our income tax returns!

Were you aware that - sometimes - you can do just that?

The fine print

Even though the interest you pay on a loan is not usually deductible, there is one exception: the tax authorities will allow you to deduct the interest on loans used to generate income. This could be business income, income associated with property (rent, for example), or income from an investment, such as royalties, dividends or interest.

Careful, though: not all forms of income are eligible. If the loan is used to earn tax-exempt income, the interest will obviously not be tax deductible. The same thing is generally true if the loan is invested in a life insurance policy. Other criteria may also apply, but this possibility of deducting interest still opens the door to some very attractive options.

Restructuring your debt to make it deductible

For example, it is possible for a taxpayer to restructure his or her loans in order to ease the tax burden.

Suppose that you took out a loan to finance the purchase of your condominium. Suppose also that you have an unregistered account where you hold 1,000 dividend-paying shares of a public company. Instead of paying non-deductible interest on your personal loan, you could sell your 1,000 shares, use the proceeds of the sale to partially or fully repay the loan, and then take out a new loan to repurchase 1,000 shares of the same company. Since this new loan would be used to generate income, the interest is deductible - and you have just converted a non-deductible debt into a deductible one without increasing your liabilities in any way.

Get good advice

Many other strategies could also be considered, especially if you own a business. Please note, however, that there is a mountain of case-law on this issue, and the taxman is very alert for any kind of sleight-of-hand that certain taxpayers might find tempting. If you'd like to know more about what is and isn't allowed, check out the Canada Revenue Agency's interpretation bulletin on this topic.

Better still: ask your financial services professional or your accountant!