Tax Wiki

Guide

Use of borrowed money

Interest on borrowed money used to purchase investments that can pay income is deductible under paragraph 20(1)(c) of the Income Tax Act.[1] The Smith Manoeuvre is a HELOC against the house used to purchase those investments.

Two loans

The mortgage and the HELOC can both be loans against the house. The mortgage purchased the house you live in, so that interest stays personal. The HELOC is a later borrowing. If you use that money to purchase shares that can pay dividends, the HELOC interest can be deductible.[2] Paying the mortgage down does not change what the HELOC was used for.

HouseMortgage (personal)HELOC (20(1)(c))

Paying down and borrowing again

Ms. A owns 1,000 listed shares and a mortgage.[3] She sells the shares, pays the mortgage down, borrows the same amount from the bank, and purchases another 1,000 shares.

Ms. ABrokerBanksells 1,000 sharespays the mortgage downlends the same amountpurchases 1,000 shares

The new borrowing purchased shares, so the interest on it can be deducted.[4]

One line, two uses

A mortgage and a HELOC are two loans. Personal spending and a share purchase from the same line of credit are two uses of one loan. A later payment reduces that loan in the same ratio as the draws.[5]

CRA's example is a $100,000 line, $60,000 personal and $40,000 for shares. After a $20,000 payment, the share part is $32,000. Taking the $20,000 off the personal part alone would have left $40,000 of shares.

two loansMortgageHELOC $40,000pay the mortgageMortgageHELOC $40,000one linepersonal $60,000shares $40,000pay $20,000personal $48,000shares $32,000

Income

The purpose has to be income from the property. A reasonable expectation is enough, and the income can be smaller than the interest.[6] Common shares generally qualify even with no dividend. CRA treats the interest as deductible unless the corporation has said it will not pay dividends and shareholders can realize their value only by a sale.[7]

A stated interest or dividend rate is enough unless the arrangement is a sham.[6]

Where it fails

Interest on a HELOC draw used for personal spending is personal. Interest on a contribution to a TFSA, RRSP, or FHSA cannot be deducted, and the deduction ends if the shares later go into one of those plans.[8] Interest added to the HELOC principal is compound interest. You deduct it only when you pay it.[9] Québec can limit the deduction to the year's investment income.[10]

The deduction reduces ordinary income. The ordinary column of the rate tables is the rate that applies.

  1. Income Tax Act s. 20(1)(c)
  2. Folio S3-F6-C1 ¶1.92
  3. Folio S3-F6-C1 ¶1.33
  4. Singleton v Canada, 2001 SCC 61
  5. Folio S3-F6-C1 ¶1.43
  6. Ludco Enterprises Ltd. v Canada, 2001 SCC 62 ; folio ¶1.27, ¶1.69
  7. Folio S3-F6-C1 ¶1.70 ; line 22100
  8. Income Tax Act s. 18(11)
  9. Income Tax Act s. 20(1)(d) ; folio ¶1.81 to ¶1.83
  10. Revenu Québec, line 260