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If you’re borrowing funds to support business growth and or investment growth, you may be eligible to deduct interest on your business or property income under the Income Tax Act.
What qualifies as an interest expense?
When a person or business takes out a loan and is charged interest, that expense can be deducted from your business or property income. For example, let’s say you own a chain of dental clinics and take out a loan of $50,000 at a 5% annual interest rate to buy new equipment. You would be able to deduct the $2500 you spent that year on interest in your taxes as a business expense. The same will be true if you borrowed funds for marketable security investments (such as stocks), because you could write off those interest charges against your investment income.
Even so, deducting interest isn’t always a simple process. An interest expense is only tax deductible if:
- You’re legally obligated to pay interest through a written or oral agreement. Any agreements where interest is contingent on certain factors would not qualify. For example, if your startup receives a private loan where you only have to pay interest if your company surpasses $1 million of revenue for the year. This is seen as a contingent loan and would not meet the criteria.
- The interest amount is considered reasonable based on the market. An interest charge may be eligible for partial deduction if the amount charged is deemed reasonable. In many cases, investors incur higher interest rates, which they are willing to accept. Consequently, taxpayers can potentially deduct these interest expenses against their investment income, provided specific conditions are met.
- The money you’re borrowing is being used to earn taxable income and is traceable to specific expenditures or investments. This includes buying rental properties, purchasing equipment, or buying a franchise. Stock purchases are also very likely to qualify with some exceptions, as shares can lead to dividends.
- It’s important to note that the money borrowed doesn’t have to actually lead to income or generate a profit. It simply has to be used with the goal of earning income.
- Interest can also be deducted on unpaid purchases, such as a vendor takeback mortgage for a rental property, as long as you can prove intent to earn taxable income.
- The loan isn’t used to make RESP, TFSA, or RRSP contributions, and isn’t being used on activities that go against anti-avoidance rules. Interest charges on borrowed funds to fund these types of investments do not qualify for interest deductibility.
Connecting with an experienced team is vital when navigating the complexities of the interest expense deduction rules. At Zeifmans, we’ll work with you to maximize your tax benefits. Reach out here to get started.
