The importance of interest traceability in order to obtain a tax deduction


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Section 160 of the Taxation Act1 sets out the criteria for deducting interest expense on a loan. There are four cumulative conditions:

  1. The expense must be paid or payable during the fiscal year;
  2. The expense must be paid in fulfillment of a legal obligation to pay interest on borrowed money;
  3. The borrowed money must be used to earn non-exempt income from a business or property;
  4. Given the first three criteria, the expense must be reasonable.

In a recent decision2, the Court reiterated the importance of tracing borrowed funds and proving that they are used for identifiable income and expenses.

[12] In order for the third condition of section 160 to be met […], the taxpayer’s actual purpose and use of the borrowed funds is examined, and a direct link between the borrowed money and an eligible use must be demonstrated […]. This direct link raises the question of the traceability of the borrowed funds and their materialization in identifiable income and expenses. […] The taxpayer has the obligation to trace the borrowed funds over the years and to demonstrate that he still has possession of them up to the current eligible use corresponding to the tax year claimed […].

[…]

[14] In light of the evidence, the Tribunal considers that traceability […] is diffused in the Taxpayer’s numerous business activities presumably carried out using multiple sources of money to generate income, and that therefore the interest expenses claimed in 2014, 2015 and 2016 cannot reasonably be considered to relate to mortgage refinancing. Consequently, the Taxpayer does not demonstrate with sufficient prima facie reliability that the claimed interest expenses qualify.1 [Our translation]

In summary, the Court concluded that the Plaintiff had not demonstrated that the financial source came directly from the mortgage refinancing; the income and expenses that resulted from the money invested in the business by the Taxpayer came back to him in the form of dividends. They are therefore not deductible.

Written in collaboration with Laury-Ann Bernier, LL.M.

1 Taxation Act, RLRQ, c. I-3.
2 Marcantonio c. Agence du Revenu du Québec, 2023 QCCQ 9551.
3 Id., par. 12 et 14.