Breaking tax rules, even if you did so unintentionally, can be costly as a Canadian taxpayer recently found out after a Tax Court of Canada (TCC) decision. This case deals with interest deductions. The rules allow borrowers to deduct interest on their borrowed funds, but these funds must meet specific criteria. The money borrowed needs to be used for taxable purposes, such as mutual funds, or for earning other sorts of non-exempt income, such as the acquisition of rents. The borrower got it almost right. He did borrow to invest in mutual funds. But, then he got some of the capital back. Had he continued to put the money back into his investments, then this would have been all right. Unfortunately, the investor used the funds for personal expenditures, removing his ability to deduct interest. And, even though the percentage used for personal use was small, it was no longer possible to show a clear trail from borrowing to purpose. Understanding the fine print of tax law in this case would have saved this borrower a court trial and defeat.

Key Takeaways:

• Knowing the rules of tax planning can save you a lot of money and help you avoid costly mistakes.
• The rules around interest deductions can be complicated, but there are some general principles that apply here, namely the “purpose test” and “direct use” test.
• If borrowing money, you cannot deduct interest charges if you are taking personal interest from the funds received from the borrow money.

“Earning income from business or property is important to deducting your interest costs. Be aware that capital gains don’t count as income from property.”

Read more: https://www.theglobeandmail.com/investing/personal-finance/taxes/article-recent-court-ruling-offers-tax-guidance-on-borrowing-to-invest/