Wealth Advisor Companion: Charting Interest Deductibility for Leveraged Investing in Canada

(Part of the Taxevity Navigator Series)

As a Canadian wealth advisor, your clients may ask you about leveraged investing and how the interest on those investment loans might be tax-deductible. We’ve prepared this Companion to help you navigate these complex topics and provide your clients with informed guidance.

This simplified information is for educational purposes and offers a general overview of Canadian federal tax law regarding interest deductibility as of mid-2025. Tax rules are intricate and can change, and their application depends heavily on individual circumstances. We recommend that you also do your own research.

For specific advice tailored to your clients’ unique situations, we always recommend they consult with their own independent accountant or tax advisor. These professionals are best equipped to ensure any strategy aligns with the client’s complete financial picture and complies with all current regulations. This Companion is intended to help you in your discussions and due diligence, not to serve as standalone official reference material.

1. Executive Summary

Understanding the rules governing the tax deductibility of interest on funds borrowed for investment purposes is essential for wealth advisors guiding clients through leveraged investing strategies. The Canadian federal tax system, primarily through paragraph 20(1)(c) of the Income Tax Act, permits the deduction of interest expenses under specific conditions. Navigating these provisions, however, requires a nuanced understanding of legislative requirements, judicial interpretations, and the administrative positions of the Canada Revenue Agency (CRA).

The cornerstone of interest deductibility lies in the “purpose of earning income” test. This test requires that borrowed funds be used with a reasonable expectation of generating taxable income, such as interest, dividends, or rent, rather than solely capital gains. Equally vital is the principle of tracing, whereby taxpayers must be able to demonstrate a clear link between the borrowed funds and the specific income-earning use. The “current use” of the funds, not their original use, dictates deductibility.

As of mid-2025, the landscape has been further shaped by recent legislative changes, including the Excessive Interest and Financing Expenses Limitation (EIFEL) rules and the Hybrid Mismatch Arrangement rules, which can impact certain corporate and cross-border structures. The CRA also continues to update its administrative guidance, notably through Income Tax Folio S3-F6-C1, “Interest Deductibility”.

The increasing complexity of these rules, coupled with evolving CRA interpretations and new jurisprudence, underscores the need for a proactive and informed approach from wealth advisors. You have a pivotal role in educating your clients on these complexities, managing risks associated with leverage, and ensuring meticulous documentation is maintained to support any interest deduction claims (i.e., to substantiate the deduction if questioned by the CRA).

This Companion aims to provide you with clear, practical, and actionable insights to effectively navigate these intricate rules and guide your clients in making informed decisions about leveraged investing.

2. Fundamental Principles of Interest Deductibility in Canada

The ability for a Canadian taxpayer to deduct interest expenses incurred on borrowed money for investment purposes is primarily governed by paragraph 20(1)(c) of the Income Tax Act (the “Act”). This provision is a specific allowance, as paragraph 18(1)(b) of the Act generally prohibits the deduction of outlays that are capital in nature (acquiring an asset that provides a lasting benefit, rather than a short-term operational expense). The Act generally doesn’t allow these capital costs to be deducted against income in the year they are incurred, though specific rules allow for depreciation (Capital Cost Allowance) or other forms of recovery over time. Paragraph 20(1)(c) is an exception that specifically permits the deduction of interest related to acquiring such income-producing assets.

Understanding the foundational elements of paragraph 20(1)(c) is the first step for guiding your clients.

Paragraph 20(1)(c) of the Income Tax Act: The Legislative Basis

Paragraph 20(1)(c) permits the deduction of an amount paid in the year, or payable in respect of the year (depending on the taxpayer’s accounting method), pursuant to a legal obligation to pay interest on:

• (i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy); or
• (ii) an amount payable for property acquired for the purpose of gaining or producing income from the property or from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy).

Subparagraph 20(1)(c)(i) deals with interest on borrowed money, while subparagraph 20(1)(c)(ii) addresses interest on an amount payable for property acquired (e.g., the unpaid portion of a purchase price). A key distinction is that subparagraph 20(1)(c)(ii) does not have a “use test” in the same direct way as (c)(i), though substituted property rules under section 20.1 can become relevant if the initially acquired property is disposed.

Core Conditions for Deductibility

For interest to be deductible under paragraph 20(1)(c), several core conditions must be met:

• Legal Obligation to Pay Interest: There must be a legally enforceable obligation to pay interest. The method of deducting interest—either when paid (cash method) or when it has accrued (accrual method)—depends on the method the taxpayer regularly follows in computing their income. The liability to pay must be absolute and not contingent upon a future event that may not occur.
• Reasonableness of the Amount: The amount of interest claimed as a deduction cannot exceed what is considered a “reasonable amount”. Reasonableness is determined by factors such as prevailing market interest rates for debts with similar terms and credit risks at the time the obligation was entered into or renewed. An interest rate established in an arm’s-length transaction between a borrower and a lender is generally considered reasonable.
• This “reasonableness” criterion, while seemingly straightforward, can be a point of CRA scrutiny, especially in non-arm’s length situations or where rates appear off-market. The Quebec Court of Appeal case Brookfield Renewable Power Inc. v QRA, 2025 QCCA 234, although concerning loss consolidation, underscored that contextual factors are key in assessing the reasonableness of an interest rate, and it is a fact-driven analysis. This implies that even if a loan meets other tests for deductibility, an unusually high interest rate could be challenged by the CRA, potentially leading to a partial disallowance of the interest deduction. Advisors should therefore explain to clients that merely having a loan agreement does not guarantee full deductibility if the rate is deemed excessive, particularly in related-party transactions.
• Paid/Payable in the Year: The interest must be paid in the year or be payable in respect of the year, aligning with the taxpayer’s accounting method.

Defining “Interest” for Tax Purposes

The Income Tax Act does not provide a statutory definition of “interest”. Its meaning has been established through court decisions. Generally, an amount is considered interest if it satisfies three characteristics:

1. It is calculated on a day-to-day accrual basis.
2. It is calculated on a principal sum (or a right to a principal sum).
3. It represents compensation for the use of that principal sum.

Payments that are calculated based on profit, revenue, or cash flow (participating payments) are typically not considered interest, as they more closely resemble an equity return. However, such payments may qualify as interest if they are limited to a stated percentage of the principal that reflects prevailing arm’s-length commercial interest rates, and there are no other indications of an equity investment. If a contract does not explicitly stipulate interest but an amount can reasonably be regarded as such, section 16 of the Act may deem that amount to be interest.

3. The “Purpose of Earning Income” Test

A cornerstone of interest deductibility under subparagraph 20(1)(c)(i) is the requirement that borrowed money be “used for the purpose of earning income from a business or property”. When the Act refers to “property” in this context, it broadly includes things that can be owned and from which income can be generated, such as shares, bonds, mutual fund units, or rental real estate. It’s not limited to physical items. This “purpose test” is a question of fact and has been the subject of significant judicial interpretation.

The Ludco Standard: Reasonable Expectation of Income

The Supreme Court of Canada (SCC) in Ludco Enterprises Ltd. et al. v. The Queen (2 S.C.R. 1046, 2001 SCC 62) established the definitive test for determining purpose in the context of interest deductibility. The Court held that the requisite test is whether, considering all the circumstances, the taxpayer had a reasonable expectation of income at the time the investment was made.

It is important to note that “income” in this context refers to income in a general sense – an amount that would be included in income for tax purposes (e.g., interest, dividends, rent, royalties) – and not necessarily net income or profit. The courts are generally not concerned with the sufficiency of the income expected or actually received, provided the purpose is bona fide and there are no vitiating circumstances such as a sham or window dressing.

“Income” vs. Capital Gains: CRA and Judicial Interpretations

A critical distinction for wealth advisors to emphasize to clients is that a reasonable expectation of capital gains alone does not satisfy the income-earning purpose test for interest deductibility. The investment acquired with borrowed funds must have the potential to generate taxable income such as dividends, interest, or rent.

• Why the distinction? The Income Tax Act treats income (like interest or dividends) and capital gains differently. Interest deductibility is linked to the pursuit of generating income that is fully taxable in the year it is received or accrued. Capital gains, on the other hand, are only partially included in income and only when the asset is sold. The policy behind interest deductibility is to offset the costs of financing assets that are expected to produce ongoing, taxable income streams.
• Example 1 (Likely Deductible): A client borrows to buy shares in a well-established public company that has a consistent history of paying dividends. Even if the dividend yield is modest (e.g., 2%) and the client also hopes for capital appreciation, the reasonable expectation of dividend
  income would likely satisfy the purpose test.
• Example 2 (Potentially Problematic): A client borrows to invest in a speculative start-up company that has explicitly stated it will not pay dividends for the foreseeable future, as all profits will be reinvested for growth. The client’s sole expectation is a large capital gain if the company is eventually sold or goes public. In this scenario, the CRA would likely argue that the purpose test for earning income is not met, and the interest would not be deductible.
• Example 3 (Grey Area – Needs Careful Documentation): A client borrows to invest in a growth-focused company that currently pays no dividends but has indicated in its investor communications that it may begin paying dividends once certain profitability milestones are reached. Here, documenting the reasonable expectation of future dividend income at the time of investment is crucial. This might include analyst reports, company statements, or industry trends suggesting such a shift is plausible. Without this, the CRA might still challenge the deduction.

The CRA’s administrative position, as outlined in Income Tax Folio S3-F6-C1, reflects this. For instance, with common shares that are not currently paying dividends, the CRA will generally allow the deduction of interest expense if the shareholder has a reasonable expectation of receiving dividends at some point in the future. However, if a corporation has a stated policy that it will not pay dividends, and shareholders must rely on selling their shares to realize value, the CRA’s view is that the purpose test is not met, and interest on money borrowed to purchase these shares will not be deductible.

The Ludco decision’s acceptance of an “ancillary purpose” to earn income and its focus on “gross income” provides a degree of flexibility. However, this also means that careful articulation and documentation of the client’s income-earning intent at the time of investment are crucial, particularly for investments that might appear primarily growth-oriented. The Tax Court of Canada case, Swirsky v. The Queen (TCC 336, aff’d 2014 FCA 37), serves as a significant reminder. In Swirsky, an interest deduction was denied for money borrowed to purchase shares in a private company because there was no evidence that, at the time of purchase, the taxpayer believed or expected that dividends would be paid, and the company had no history of paying dividends. This case demonstrates that if there is no reasonable expectation of income (such as dividends), even if capital gains are anticipated, the interest will likely not be deductible.

Wealth advisors must therefore diligently probe and document the client’s expectation of income (dividends, interest, rent), not merely capital appreciation. This nuanced assessment is vital, especially for investments in private company shares or more speculative ventures.

Ancillary vs. Dominant Purpose

The Ludco decision also clarified that the income-earning purpose does not need to be the taxpayer’s exclusive, primary, or dominant purpose for acquiring the property. An ancillary or secondary purpose of earning income can be sufficient to meet the test, provided it is a bona fide objective.

4. Tracing Borrowed Funds: The Crucial Link

Once the income-earning purpose is established, the taxpayer must be able to trace the borrowed funds to an eligible income-earning use. This tracing requirement is fundamental to substantiating an interest deduction claim.

The “Direct Use” Rule: Insights from Singleton

The Supreme Court of Canada’s decision in Singleton v. Canada (2 S.C.R. 1046, 2001 SCC 61) reinforced the “direct use” test. This test requires a direct link to be drawn between the borrowed money and an eligible use. In Singleton, the taxpayer withdrew personal capital from his law firm partnership to purchase a home and, on the same day, borrowed money to replenish his capital account in the firm. The Court found that the borrowed money was directly used to refinance his investment in the partnership (an income-earning asset), and thus the interest was deductible. The transactions were viewed independently.

The Singleton “transactional independence” principle allows for restructuring, such as borrowing to reinvest in one’s own business after withdrawing equity for personal use. However, this must be executed with care to ensure the direct link between the new borrowing and the eligible investment is clear, bona fide, and not merely a sham to convert personal interest into deductible interest. While the refinancing aspect for deductibility is permissible, as acknowledged by the CRA even in the context of the Lipson case (where GAAR was applied for other reasons), the overall series of transactions must not be abusive. The CRA remains critical of tax planning that is merely a guise for deducting personal expenses. Wealth advisors should ensure that such restructuring transactions possess economic substance and that the income-earning purpose of the newly borrowed funds is genuine and thoroughly documented.

The “Current Use” Principle

Critically, interest deductibility is determined by the current use of the borrowed money in the taxation year for which the deduction is sought, not its original use. If the use of the borrowed funds changes from an eligible income-earning purpose to an ineligible (e.g., personal) purpose, the interest will cease to be deductible from the point of that change in use. The taxpayer bears the onus of establishing this link between the borrowed money and its current eligible use.

Methodologies: Direct Linking, Flexible Approach for Commingled Funds, and Cash Damming

• Direct Linking: This is the primary and most straightforward method, involving tracing the borrowed funds directly to a specific income-earning asset or expenditure. Maintaining separate accounts for borrowed funds used for investment is a best practice to facilitate direct linking.
• Commingled Funds: If borrowed funds are deposited into an account where they are mixed with other funds (e.g., personal savings, income from other sources), tracing can become more complex. In such situations, the CRA administratively permits a “flexible approach”. This allows taxpayers to identify the use of the borrowed money from among all the uses of the commingled funds, provided the transactions are timed appropriately (i.e., a use cannot be attributed to a borrowing that occurs subsequently).
• However, there is a significant limitation to this flexible approach: it does not apply to the repayment of borrowed money from a single account used for both eligible and ineligible purposes. In such cases, repayments are deemed to reduce the eligible and ineligible portions of the loan proportionally. For example, if a $10,000 line of credit was used 60% for investments and 40% for personal expenses, a $2,000 repayment will be allocated 60% ($1,200) to the investment portion and 40% ($800) to the personal portion. The client cannot choose to allocate the entire repayment to the personal portion to maximize ongoing interest deductibility. This proportional repayment rule underscores the importance of advising clients to use dedicated accounts for investment borrowings to maintain clear tracing and control over their interest deductions.
• Cash Damming: This is a financial planning strategy that leverages the CRA’s tracing rules. It involves structuring a client’s finances so that all borrowed money is demonstrably used for income-earning purposes (making the interest deductible), while personal and non-deductible expenses are paid from other cash sources, such as employment income or business revenues. This strategy requires careful planning and execution but can be effective in maximizing interest deductions.

Impact of Refinancing (Subsection 20(3))

Subsection 20(3) of the Act provides a crucial deeming rule for refinancing situations. It states that where borrowed money is used to repay money previously borrowed, or to repay an amount payable for property previously acquired, the newly borrowed money is deemed to be used for the same purpose as the original debt or to acquire the same property. This allows for the continuation of interest deductibility when loans are refinanced, provided the original purpose was eligible.

Disappearing Source Rules (Section 20.1)

Section 20.1 contains the “disappearing source rules,” which can allow interest to remain deductible even if the income source acquired with the borrowed money no longer exists or no longer produces income. These rules generally apply when borrowed money was used to acquire a capital property (other than real property, immovable property, or depreciable property) that has been disposed of (e.g., shares sold at a loss), or when a business for which money was borrowed ceases operations. If the conditions in section 20.1 are met, the borrowed money is deemed to continue to be used for the purpose of earning income, thus preserving interest deductibility on the outstanding loan balance related to that original investment.

Indirect Use: Permitted Exceptions

While the direct use test is the general rule, the CRA acknowledges certain “exceptional circumstances”, established through jurisprudence, where an indirect use of borrowed funds may still support interest deductibility. These include:

• A corporation borrowing money to redeem shares, repurchase shares for cancellation, return capital, or pay dividends, provided the borrowed funds replace capital (contributed capital or accumulated profits) that was being used for eligible income-earning purposes within the corporation. This is often referred to as the “filling the hole” concept.
• A taxpayer borrowing money to make an interest-free loan or capital contribution to a Canadian corporation in which they are a shareholder, where the funds enable the corporation to earn income, thereby increasing the taxpayer’s potential to receive dividend income from that corporation. Similar rules can apply to partnerships.

5. Qualifying Investments for Interest Deductibility

The eligibility of an investment for interest deductibility hinges on whether it was acquired with the “purpose of earning income”. This section examines common investment types.

Common Shares (Public and Private): Dividend Expectations

Interest on money borrowed to acquire common shares, whether publicly traded or in private corporations, is generally deductible if there is a reasonable expectation of receiving dividend income at the time of acquisition. This expectation can exist even if the shares are not currently paying dividends, provided there’s a prospect of future dividends.

However, if a corporation has an explicit policy of not paying dividends, and shareholders must rely solely on capital appreciation realized through the sale of shares, the CRA’s position is that the purpose test is not met, and interest will likely be non-deductible. The Swirsky case reinforced this for private company shares where there was no history or expectation of dividends.

Fixed Income: Bonds and GICs

Investments like bonds and Guaranteed Investment Certificates (GICs) are inherently designed to produce interest income. Therefore, interest on funds borrowed to acquire these types of assets generally qualifies for deduction, as they clearly meet the income-earning purpose test. The interest earned from GICs is fully taxable as interest income to the investor.

Collective Investment Vehicles: Mutual Funds and ETFs

Interest on loans used to purchase units of mutual funds or Exchange-Traded Funds (ETFs) is generally deductible if these vehicles are expected to distribute income, such as interest or dividends. The character of the distributions from the fund (e.g., interest, Canadian dividends, foreign income, capital gains, or Return of Capital) affects how the investor is taxed on those distributions, but the key for interest deductibility on the loan is the reasonable expectation of receiving income distributions from the fund.

Segregated Fund Contracts (Subsection 20(2.2))

A specific exception exists under subsection 20(2.2) of the Income Tax Act for certain non-registered segregated fund contracts. Even though segregated funds are legally life insurance policies (interest on loans to acquire which is generally not deductible), this provision allows for the deduction of interest on borrowed money used to purchase qualifying non-registered segregated fund contracts.

Income-Producing Real Estate

Interest on mortgages or loans taken out to acquire real estate that generates rental income is generally deductible. If only a portion of a property (e.g., a principal residence) is used to earn rental income, a proportionate share of the mortgage interest may be deductible, based on factors like the square footage used for rental purposes.

Impact of Return of Capital (ROC) on Deductibility

A critical issue for many income-focused investments, particularly certain mutual funds (e.g., T-series funds) or ETFs, is the treatment of distributions characterized as Return of Capital (ROC). An ROC distribution is essentially the fund returning a portion of the investor’s original invested capital.

If a client receives an ROC distribution from an investment that was acquired with borrowed money, and those ROC funds are not reinvested into another income-earning asset or used to pay down the principal of the investment loan, but are instead used for personal (ineligible) purposes, the portion of the loan interest corresponding to the ROC used personally will cease to be deductible. The CRA’s position, supported by the Tax Court of Canada in Van Steenis v. The Queen (TCC 78), is that the direct link between that portion of the borrowed money and an eligible income-earning use has been broken. The ROC effectively reduces the amount of borrowed money that is still being used for its original income-earning purpose. ROC distributions also reduce the Adjusted Cost Base (ACB) of the investment.

This treatment of ROC is a significant potential pitfall. Clients might be attracted to ROC distributions due to their short-term tax efficiency (as ROC itself is not immediately taxable income but reduces ACB). However, if these funds are not managed correctly with respect to the associated investment loan, it can inadvertently reduce their interest deductibility. Wealth advisors must proactively educate clients about this, emphasizing that ROC received should ideally be reinvested in income-producing assets or used to reduce the investment loan principal to maintain full interest deductibility on the original loan amount. This necessitates ongoing monitoring of investment distributions and their characterization.

The following table provides a summary of common investment types and key considerations for interest deductibility:

Table 1: Summary of Qualifying Investments and Key Considerations for Interest Deductibility

6. Investments and Uses Generally Not Qualifying for Interest Deductibility

While paragraph 20(1)(c) provides for the deduction of interest, certain uses of borrowed funds and types of investments inherently fail to meet the required tests, rendering the associated interest non-deductible. These expenditures typically fail the primary test of being incurred for the purpose of earning taxable income from a business or investment property.

Focus Solely on Capital Appreciation

As discussed in Section 3, if an investment is acquired with the sole expectation of realizing capital gains, and there is no reasonable expectation of earning taxable income (such as dividends, interest, or rent), interest on money borrowed to acquire that investment is generally not deductible. The “purpose of earning income” test is not met in such instances. For example, investing in common shares of a company with a stated policy of never paying dividends would fall into this category.

Contributions to Registered Plans (RRSPs, TFSAs, RESPs)

Interest on money borrowed to make contributions to Registered Retirement Savings Plans (RRSPs), Tax-Free Savings Accounts (TFSAs), Registered Education Savings Plans (RESPs), First Home Savings Accounts (FHSAs), and other similar registered deferred income plans is explicitly not deductible. This is a fundamental rule that wealth advisors must clearly communicate. The rationale is that income earned within these plans already benefits from tax-sheltering or tax-deferral, and allowing an interest deduction on contributions would provide an unintended double tax benefit. Clients might be tempted to borrow to maximize contributions to these plans, but the interest cost itself will not be tax-relieved, which significantly impacts the net return of such a strategy.

Personal Use Assets

Interest on money borrowed to acquire assets for personal use and enjoyment, such as a principal residence (for the portion not used to earn income), personal vehicles, or a family cottage used exclusively for recreation, is not deductible. These expenditures fail the primary test of being incurred for the purpose of earning taxable income from a business or investment property.

Vacant Land (Without Income Generation)

Interest on money borrowed to acquire vacant land is generally not deductible if the land is not currently producing income (e.g., through rent or farming). Paragraph 18(2)(a) of the Act restricts the deduction of interest (and property taxes) on land unless the land is used in the course of a business carried on in the year by the taxpayer (other than a business that is the leasing of the land to a lessee that is not using it in its business) or the land is primarily held for the purpose of gaining or producing income of the taxpayer from the land for the year. Even when some income is earned, the deduction for interest and property taxes on vacant land is generally limited to the net rental income earned from that land after deducting all other expenses; these costs cannot be used to create or increase a rental loss or reduce other sources of income. Any undeducted interest and property taxes may, in certain circumstances, be added to the adjusted cost base (ACB) of the land, reducing the capital gain (or increasing the capital loss) upon its eventual disposition.

Direct Acquisition of Life Insurance Policies

Subparagraph 20(1)(c)(i) specifically denies a deduction for interest on borrowed money used to acquire a “life insurance policy” as defined in subsection 138(12) of the Act. This prohibition is a long-standing feature of Canadian tax law.

There are, however, important exceptions:

• Subsection 20(2.2): This provision allows for the deductibility of interest on borrowed funds used to acquire certain policies that are excluded from the definition of a life insurance policy for this purpose. Most notably for investment advisors, this includes non-registered segregated fund contracts.
• “10/8 Policies”: It’s important to distinguish these from standard insurance leveraging strategies. These “10/8 policies” were specific leveraged life insurance arrangements where the policy’s design (often linking its investment return directly to the borrowing costs of an associated loan, or where the maximum investment account was tied to the loan amount) was primarily aimed at generating an interest deduction, often with an engineered spread. These were not typically about using unborrowed money for premiums with a separate loan for external investment. Rather, the structure itself was designed to create the interest deduction in a way the CRA viewed as exploiting the rules. For taxation years ending after March 20, 2013, subsection 20(2.01) was introduced to specifically deny interest deductions related to these “10/8 policies”. This legislation targeted the specific mechanics of those arrangements that were deemed to create unintended tax benefits.

Policy Loans (Paragraph 20(1)(d) Considerations)

Interest paid on a “policy loan” (an amount advanced by an insurer to a policyholder under the terms of a life insurance policy in Canada) may be deductible under paragraph 20(1)(c) or, if it is compound interest, under paragraph 20(1)(d), provided the proceeds of the policy loan are used for an eligible income-earning purpose (e.g., invested in dividend-paying stocks).

However, subsection 20(2.1) imposes a condition: the deduction is not allowed unless the insurer verifies, on prescribed Form T2210 (“Verification of Policy Loan Interest by the Insurer”), that the amount was interest paid in the year on the policy loan and that this interest was not added to the adjusted cost basis of the policyholder’s interest in the policy.

7. Collateral for Investment Loans: Dispelling Misconceptions

A common area of confusion for clients undertaking leveraged investing is the role of collateral in determining interest deductibility. It is crucial for wealth advisors to clarify that the type of asset pledged as security for a loan is not the determining factor for whether the interest on that loan is tax-deductible.

Use of Funds vs. Type of Collateral

The CRA’s Income Tax Folio S3-F6-C1, at paragraph 1.92, is explicit on this point: “The nature of the security provided in connection with borrowed money, or an amount payable for property acquired, has no impact on the tests for interest deductibility”. The folio further clarifies that whether an individual uses their principal residence, other personal property, or an income-earning property as security is irrelevant. What matters is the use of the borrowed money and the purpose of that use.

Therefore:

• If a client borrows money against their principal residence (e.g., via a Home Equity Line of Credit – HELOC) and uses those funds to purchase income-producing investments (like publicly traded stocks that pay dividends), the interest on that HELOC may be deductible, provided all other conditions are met.
• Conversely, if a client borrows money against their investment portfolio and uses the funds for personal expenses (e.g., a vacation or home renovations), the interest on that loan is not deductible, even though income-producing assets were pledged as collateral.

This distinction is fundamental. Many leveraged investing strategies, such as the Smith Manoeuvre, are predicated on this principle, allowing homeowners to use the equity in their personal residence to secure loans for investment purposes, with the aim of making the interest on those loans tax-deductible. Wealth advisors must clearly and repeatedly emphasize that an auditable trail demonstrating the direct use of the borrowed funds for an eligible income-earning purpose is essential, irrespective of the collateral pledged. Misunderstanding this can lead to clients incorrectly assuming interest is not deductible when personal assets are used as collateral, or, conversely, attempting to deduct interest on personal loans simply because investments were pledged.

Common Collateral Types

Lenders in Canada accept a variety of assets as collateral for investment loans, including:

• Real estate: This includes a principal residence (often through HELOCs), rental properties, or other real property holdings.
• Marketable securities: Portfolios of publicly traded stocks, bonds, mutual funds, and ETFs are commonly used as collateral for margin loans from brokerages or secured lines of credit from banks.
• Guaranteed Investment Certificates (GICs): Due to their low-risk nature and guaranteed principal, GICs can be used to secure loans, often at favourable Loan-To-Value (LTV) ratios.
• Life insurance policies: The Cash Surrender Value (CSV) of permanent life insurance policies can be used as collateral, notably in Immediate Financing Arrangements (IFAs) and Insured Retirement Plans (IRPs).
• Other business assets: For business loans, collateral can include equipment, inventory, and accounts receivable.

The choice of collateral will influence the loan terms, including the interest rate and the LTV ratio offered by the lender, but it will not determine the tax deductibility of the interest paid.

8. Typical Loan-to-Value (LTV) Ratios in Canada for Leveraged Investing

Loan-To-Value (LTV) ratio is a key metric used by lenders to assess the risk associated with a secured loan. It represents the ratio of the loan amount to the appraised value of the asset pledged as collateral. A lower LTV generally signifies lower risk for the lender and may result in more favourable loan terms for the borrower. LTV ratios are not static and vary based on the type of asset used as collateral, its liquidity, market conditions, the lender’s internal policies, and regulatory guidelines.

(Wealth advisors may wish to substitute the example financial institutions mentioned below with those more commonly recognized or preferred by their clientele.)

LTVs for Marketable Securities (Stocks, Bonds, Mutual Funds)

• Brokerage Margin Loans: The Canadian Investment Regulatory Organization (CIRO), formerly the Investment Industry Regulatory Organization of Canada (IIROC), sets margin requirements for investment dealers.
  • For most equity securities trading at or above $2.00 per share, the typical minimum margin requirement is 50%, meaning a client can borrow up to 50% of the securities’ value (an LTV of 50%).
  • For certain highly liquid, low-volatility securities (often referred to as “exempt list” securities), the margin requirement can be lower, such as 30%, allowing for an LTV of up to 70% for client positions.
  • Securities trading below $1.50 per share generally have a 100% margin requirement, meaning they cannot be purchased on margin (0% LTV for loan purposes).
  • CIRO has been developing a Value-at-Risk (VaR) based methodology for calculating equity margins, which considers price and liquidity risk for individual securities.
  • Structured products, due to their complexity and liquidity characteristics, may have higher margin requirements, for example, a fixed rate of 70% or a component-based methodology.
• Bank Loans Secured by Marketable Securities: Banks and other financial institutions also provide loans secured by portfolios of marketable securities.
  • Lenders generally prefer highly liquid assets such as publicly traded stocks, bonds, and mutual funds.
  • LTVs can vary: Some sources suggest LTVs for marketable securities can be up to 90% (e.g., BDC example) or specific ranges like up to 80% for public equities and fund LP ownership, up to 85% for investment-grade bonds, and up to 70% for private equities (e.g., Avon River Ventures example). TD Bank offers an Investment Secured Line of Credit using eligible investments as collateral, with the LTV presumably determined by the quality and diversification of the pledged portfolio.

LTVs for Real Estate (including HELOCs)

• Conventional Mortgages: For purchasing residential property, the maximum LTV is generally 80% if the mortgage is uninsured (i.e., a down payment of at least 20%). With mortgage default insurance, the LTV can go as high as 95% (a 5% down payment) for qualifying borrowers and properties.
• Home Equity Lines of Credit (HELOCs): The maximum LTV for the HELOC component itself is typically 65% of the property’s value. However, the total of the conventional mortgage and the HELOC secured against a property generally cannot exceed 80% of the property’s value. Guidelines from the Office of the Superintendent of Financial Institutions (OSFI) influence these limits for federally regulated lenders.
• Refinancing: When refinancing a mortgage, the maximum LTV is typically 80% of the property’s appraised value.
• Commercial/Industrial Real Estate: LTVs can be more variable, ranging from 65% to potentially 100% depending on factors like the strength of the business, market conditions, and property type.

LTVs for GICs

Guaranteed Investment Certificates are considered low-risk collateral due to their principal protection and fixed returns. Some institutions (e.g., SBI Canada Bank example) offer loans up to 95% of the value of GIC deposits held with their institution. Other institutions may have similar programs.

LTVs for Life Insurance Policies (e.g., in IFA or IRP Structures)

Immediate Financing Arrangements (IFAs) and Insured Retirement Plans (IRPs) often use the cash surrender value (CSV) of a permanent life insurance policy as collateral for a loan. Lenders specializing in these strategies may advance up to 90% or even 100% of the policy’s CSV. Some institutions note the potential to finance up to 100% of the annual premium in an IFA context.

The variability in LTV ratios across different asset classes highlights that a client’s “borrowing power” is not uniform. Wealth advisors must explain that the specific assets a client intends to pledge as collateral will significantly influence the amount of leverage they can achieve.

The following table provides a consolidated overview of typical LTV ratios, ranked by typical LTV range in decreasing order:

Table 2: Typical Loan-to-Value (LTV) Ratios by Asset Class in Canada (Mid-2025)

Note: These LTV ranges are indicative and can vary based on the specific lender, borrower qualifications, market conditions, and the specific characteristics of the collateral.

9. Recent Developments (Mid-2025)

The legal and administrative landscape governing interest deductibility and related tax matters is continually evolving. Wealth advisors should stay informed of recent legislative changes, CRA administrative updates, and influential court decisions. Clients achieve optimal outcomes by consulting their tax advisors.

Excessive Interest and Financing Expenses Limitation (EIFEL) Rules

Significant changes were introduced by S.C. 2024, c.15 (formerly Bill C-59), which enacted the EIFEL rules through new sections 18.2 and 18.21, and paragraph 12(1)(l.2) of the Income Tax Act. These rules generally apply to taxation years of corporations and trusts that begin on or after October 1, 2023.

The EIFEL regime aims to limit the amount of net interest and financing expenses (IFE) that certain taxpayers (primarily corporations, trusts, and partnerships of which corporations or trusts are members) can deduct in computing their income. The deduction is generally restricted to a fixed ratio of the taxpayer’s “adjusted taxable income”, which is conceptually similar to earnings before interest, taxes, depreciation, and amortization (EBITDA). For most affected taxpayers, the permissible ratio is 30% (or 40% for taxation years beginning in 2023, if certain conditions for the transitional rule are met).

Who is likely affected by EIFEL?
While these rules are complex, they are not expected to impact most small and medium-sized Canadian-controlled private corporations (CCPCs) that wealth advisors typically serve. The legislation includes several important exclusions:

• Small CCPC Exclusion: CCPCs (and their associated corporate groups) with taxable capital employed in Canada of less than $50 million in the preceding taxation year are generally excluded. This threshold aligns with the point where the federal small business deduction begins to be reduced.
• Low Net Interest Expense Exclusion: Corporations or corporate groups with aggregate net interest and financing expenses of $1 million or less in a taxation year are also typically excluded.
• Certain Standalone Corporations/Groups: There are also exclusions for groups consisting only of Canadian-resident corporations that conduct substantially all of their business in Canada, provided they meet other specific conditions related to foreign affiliates and non-resident ownership.

Therefore, for the typical incorporated professional or small business owner client, these EIFEL rules are unlikely to limit the deductibility of interest on investment loans, provided their corporate structure and financial scale remain within these exemption thresholds. However, for larger corporate clients or those with more complex international structures, EIFEL could be a significant consideration, potentially limiting interest deductions even if the traditional tests under paragraph 20(1)(c) are met.

Hybrid Mismatch Arrangement Rules

The same legislative package (S.C. 2024, c.15) also introduced section 18.4, containing rules to address hybrid mismatch arrangements. These rules generally apply to payments arising after June 30, 2022. Hybrid mismatch arrangements are cross-border tax planning strategies that exploit differences in the income tax treatment of an instrument or entity under the laws of two or more countries to achieve a “deduction/non-inclusion” outcome or a “double deduction” outcome. These rules are highly technical and primarily relevant for clients with international investment or financing structures.

Key Updates to CRA’s Income Tax Folio S3-F6-C1

The CRA updated Income Tax Folio S3-F6-C1, “Interest Deductibility,” on August 8, 2024. Key changes include:

• References to the new EIFEL rules (sections 18.2, 18.21, paragraph 12(1)(l.2)).
• References to the new hybrid mismatch rules (section 18.4).
• Inclusion of more recent case law concerning the meaning of “for the purpose of earning income from a business or property.”
• Clarification that interest on borrowed money used to repurchase shares for cancellation can be an exception to the direct use test.
• Reference to section 143.4 concerning contingent amounts.
• Various other revisions and expansions related to participating payments, tracing repayments in commingled accounts, annuity contracts, policy loans, and 10/8 policies.

Impact of Recent Jurisprudence (2024-Mid-2025)

Several court decisions in 2024 and early 2025, while not all directly focused on paragraph 20(1)(c), have implications for tax planning and dispute resolution:

• Total Energy v The King, 2025 FCA 77: This Federal Court of Appeal (FCA) decision applied the Supreme Court’s GAAR principles from Deans Knight broadly, signaling continued scrutiny of transactions perceived as abusive. This is relevant for wealth advisors considering more aggressive leveraged strategies.
• Brookfield Renewable Power Inc. v QRA, 2025 QCCA 234: The Quebec Court of Appeal emphasized that the reasonableness of interest rates in related-party loss consolidation arrangements is a fact-driven analysis considering contextual factors. This reinforces the need for careful justification of interest rates in non-arm’s length borrowings.
• Csak v Canada, 2025 FCA 60: The FCA found that waivers of the normal reassessment period can benefit taxpayers by providing more time for submissions or narrowing issues in dispute.
• Uppal Estate v The King, 2025 TCC 34: The Tax Court held that the Crown is generally restricted by the auditor’s assessment in its pleadings.
• 3295940 Canada Inc., 2024 FCA 42: The FCA found no abusive tax avoidance in a specific context involving subsection 55(2) where alternative non-abusive transactions could have achieved similar tax results.
• Glencore Canada Corporation v. Canada, 2024 FCA 3: This case dealt with the income tax treatment of break fees, which, while not directly about interest, is relevant for wealth advisors involved with corporate transactions.

Capital Gains Inclusion Rate Deferral

A significant development for investors is the federal government’s announcement on January 31, 2025, to defer the implementation of the proposed increase in the capital gains inclusion rate. The 2024 federal budget had proposed to increase the inclusion rate from one-half (50%) to two-thirds (66.67%) for capital gains realized on or after June 25, 2024, for corporations and trusts, and for individuals on the portion of capital gains exceeding $250,000 annually. This proposal has been deferred to January 1, 2026. Consequently, the 50% capital gains inclusion rate remains in effect for the 2024 and 2025 taxation years for all taxpayers. This deferral is a positive development for investors, including those employing leverage, as it maintains the current, more favourable tax treatment of capital gains for at least two more years.

10. Practical Guidance for Wealth Advisors

Navigating the complexities of interest deductibility for leveraged investing requires wealth advisors to provide comprehensive guidance encompassing client suitability, meticulous documentation, thorough education, and careful strategy selection. It’s prudent to approach these discussions with an educational mindset, focusing on best practices rather than prescriptive directives.

Client Suitability, Risk Assessment, and Disclosure for Leveraged Strategies

Before exploring any leveraged investing strategy, a thorough assessment of the client’s suitability is essential. This includes evaluating their:

• Risk Tolerance: Leveraged investing inherently magnifies both potential gains and potential losses. Clients need to be comfortable with this increased volatility. It’s important to explain that losses can exceed their initial capital investment because, in addition to any decline in the investment’s value, they remain responsible for repaying the full loan amount plus all accrued interest.
• Investment Timeline: Leveraged investing is generally more appropriate for clients with a long-term investment horizon (e.g., 10 years or more), allowing time to ride out market fluctuations.
• Income Stability and Cash Flow: Clients must have stable income and sufficient cash flow to service the loan interest payments, irrespective of the investment’s performance. They should not rely on income from the investments to repay the loan or cover living expenses.
• Sufficient Taxable Income: For the interest deduction to be valuable, the client must have sufficient taxable income to offset. If a client has minimal taxable income, the benefit of an interest deduction is reduced or eliminated.
• Overall Financial Situation: Existing debts, financial obligations, and proximity to retirement are important considerations.

Wealth advisors have a responsibility to provide full disclosure of the risks involved. This includes explaining that market instability can lead to rapid losses, the loan must be repaid regardless of investment performance, and in worst-case scenarios, other assets (including a home, if used as collateral) could be at risk. Using leverage risk disclosure documents, such as those previously mandated by MFDA (now part of CIRO), is a sound practice.

Documentation Best Practices: Establishing the Audit Trail

Meticulous record-keeping is vital for substantiating interest deduction claims. Wealth advisors should stress to clients the importance of:

• Tracing Funds: Maintaining clear records that trace the borrowed funds directly from the loan account to the purchase of specific eligible investments.
• Separate Accounts: Using separate bank accounts and investment accounts exclusively for borrowed funds and the investments acquired with them. This avoids commingling with personal funds and simplifies tracing.
• Retaining Documents: Keeping copies of all loan agreements, bank statements showing the flow of funds, investment purchase confirmations (trade tickets), brokerage statements, and relevant tax slips (e.g., T5s for investment income, T5008s for dispositions).
• Documenting Purpose: Wealth advisors should maintain notes, and encourage clients to keep records (e.g., investment policy statements, correspondence) that document the income-earning purpose at the time the investment is made.

Client Education: Explaining Purpose, Tracing, and Current Use

Clear and ongoing client education is a key responsibility. Wealth advisors should ensure clients understand:

• The “purpose of earning income” test and that an expectation of capital gains alone is insufficient for interest deductibility.
• The “direct use” rule and the necessity of linking the borrowed money to a specific income-producing investment.
• The “current use” principle: deductibility depends on how the funds are used now, not how they were originally used. If the use changes to an ineligible one (e.g., selling investments and using proceeds for personal consumption), deductibility is lost for that portion of the loan.
• How refinancing an investment loan can maintain interest deductibility if structured correctly (per subsection 20(3)).
• The implications of the disappearing source rules if an investment is sold at a loss.

Managing Commingled Funds and Return of Capital Distributions

• Commingled Funds: While the CRA allows a “flexible approach” to tracing if borrowed funds are mixed with other cash, wealth advisors should explain its limitations, especially the proportional allocation rule for loan repayments. The best practice remains to avoid commingling.
• Return of Capital (ROC): This is a critical area for client education. Wealth advisors must explain that if ROC distributions are received from an investment (e.g., certain mutual funds or ETFs) and are used for personal expenses rather than being reinvested or used to pay down the investment loan, the interest deductibility on the corresponding portion of the loan will be lost. The Van Steenis case serves as a clear warning.

Advising on Specific Strategies

• The Smith Manoeuvre:
  • Mechanics: This strategy involves arranging a readvanceable mortgage that includes a home equity line of credit (HELOC). As the principal portion of the mortgage is paid down, the available credit on the HELOC increases. These HELOC funds are then systematically borrowed and invested in income-producing assets. The interest paid on the HELOC portion used for investment may then be tax-deductible.
  • Benefits: The primary goal is to convert non-deductible mortgage interest into potentially tax-deductible investment loan interest, thereby reducing taxes and accelerating wealth accumulation by building an investment portfolio while paying down a mortgage.
  • Risks: Significant risks include investment market volatility (investments could underperform or lose value), rising interest rates on the HELOC (which are typically variable), the complexity of managing the strategy, and the fact that the home is pledged as collateral.
  • Deductibility Criteria: For the HELOC interest to be deductible, the borrowed funds must be meticulously traced to the purchase of investments that have a reasonable expectation of generating income (not just capital gains). Strict separation of HELOC funds used for investment from any personal draws is essential. All CRA rules regarding purpose and tracing must be adhered to.
  • Advisor Role: Requires careful explanation, suitability assessment, and ongoing monitoring. Collaboration with mortgage brokers and accountants is often advisable.
• Insured Retirement Plans (IRPs)
  • Structure (IRP): An IRP also uses a permanent life insurance policy. Premiums are paid (often for a set period), building up CSV. Later, typically in retirement, funds are accessed by taking policy loans or leveraging the CSV with a third-party lender to supplement retirement income, with the loan ideally repaid from the tax-free death benefit.
  • Tax Considerations (IRP Loan Interest): If loans (policy loans or third-party loans collateralized by the policy) in an IRP are used for personal consumption (e.g., retirement income), the interest is generally not tax-deductible. If IRP loan proceeds were used for eligible income-earning investments, then interest deductibility rules would apply as usual.
  • Suitability: An IRP is generally used by sophisticated, high-net-worth clients or corporations with the capacity for substantial premium payments, a long-term investment horizon, and a tolerance for leverage.
  • Advisor Role: Involves coordinating with insurance specialists, lenders, and tax professionals. Careful structuring and ongoing management are crucial.
• Immediate Financing Arrangements (IFAs):
  • Structure (IFA): An IFA typically involves a corporation (or high-net-worth individual) purchasing a permanent life insurance policy (often whole life with high early cash values) and then using the policy’s cash surrender value (CSV) as collateral to secure a loan from a third-party financial institution. The loan proceeds are then invested in income-producing assets or used in the business.
  • Tax Considerations (IFA Loan Interest): If the borrowed funds in an IFA are directly traced to an eligible income-producing investment, the loan interest paid may be tax-deductible for the borrower. The life insurance policy itself offers tax-sheltered growth of the CSV and a tax-free death benefit (which can create a capital dividend account credit for a corporation).
  • Suitability: This complex strategy is generally suited for sophisticated, high-net-worth clients or corporations with significant life insurance needs, the capacity for substantial ongoing premium payments, a long-term investment horizon, and the ability to generate sufficient taxable income to utilize any interest deductions. A high tolerance for leverage and complexity is also required.
  • Advisor Role: Involves coordinating with insurance specialists, lenders, and tax professionals. Careful structuring and ongoing management are crucial. The EIFEL rules may also need to be considered for corporate IFAs.

Wealth advisors play an essential role not just in the initial setup of complex strategies like the Smith Manoeuvre, IFAs, or IRPs, but in their ongoing management. These are not “set and forget” approaches. They demand continuous monitoring of investment performance, interest rates, and the client’s financial situation, strict adherence to administrative discipline (like maintaining separate accounts and correctly handling ROC), and adaptability to changes in tax legislation or the client’s circumstances. Mistakes in execution, such as commingling funds or misusing ROC, can easily jeopardize the anticipated tax benefits.

Common Pitfalls and CRA Red Flags

Wealth advisors should make clients aware of common issues that can attract CRA scrutiny or lead to the denial of interest deductions:

• Inadequate or non-existent documentation to trace the use of borrowed funds.
• Investing borrowed funds in assets with no reasonable expectation of producing taxable income (e.g., solely for capital appreciation).
• Using Return of Capital distributions for personal expenses without a corresponding reduction in the deductible interest claimed.
• Attempting to deduct interest on loans used to contribute to RRSPs, TFSAs, or other registered plans.
• Loan arrangements, especially non-arm’s length ones, with interest rates or terms that are not commercially reasonable.
• Lack of contemporaneous documentation supporting the income-earning purpose at the time the investment was made.
• Commingling borrowed investment funds with personal funds, making tracing difficult or impossible.

The following checklist can serve as a framework for wealth advisors when discussing leveraged investing:

Table 3: Wealth Advisor Checklist for Discussing Leveraged Investing with Clients

11. Key References and Further Reading for Wealth Advisors

To maintain a high level of expertise and provide informed advice on leveraged investing and interest deductibility, Canadian Wealth Advisors may find it helpful to familiarize themselves with the following core legislative provisions, CRA publications, and landmark judicial decisions.

Core Legislation and CRA Publications:

• Income Tax Act (R.S.C., 1985, c. 1 (5th Supp.)):
  • Paragraph 20(1)(c): The primary provision for interest deductibility.
  • Paragraph 18(1)(b): General prohibition of capital outlays.
  • Subsection 20(3): Refinancing rules.
  • Section 20.1: Disappearing source rules.
  • Subsections 20(2.01), 20(2.1), 20(2.2): Rules related to life insurance policies, policy loans, and segregated funds.
  • Sections 18.2, 18.21, and paragraph 12(1)(l.2): Excessive Interest and Financing Expenses Limitation (EIFEL) rules.
  • Section 18.4: Hybrid Mismatch Arrangement rules.
  • Section 16: Deemed interest.
  • Paragraph 20(1)(d): Compound interest.
• CRA Income Tax Folio S3-F6-C1, “Interest Deductibility”: This is the CRA’s primary administrative guidance document, replacing IT-533. Wealth advisors should always refer to the latest version and its Chapter History for updates.
• CRA Form T2210, “Verification of Policy Loan Interest by the Insurer”: Required for deducting interest on policy loans.
• CRA Guide T4037, “Capital Gains”: Provides information on reporting capital gains and losses.
• CRA information on Line 22100 – Carrying charges and interest expenses: Found in the general income tax guide, it lists deductible and non-deductible interest and carrying charges.
• Archived/Cancelled Interpretation Bulletins (ITs): While superseded by folios, older ITs (e.g., IT-533, IT-355 on policy loans, IT-153 and IT-456 on land) can sometimes provide historical context or detail on specific issues not yet fully elaborated in folios. They should be used with caution and awareness of their status.

Landmark Judicial Decisions (Summaries and Implications):

Understanding key court cases is crucial as they interpret the Act and shape the CRA’s administrative positions.

• Ludco Enterprises Ltd. et al. v. The Queen, 2001 SCC 62: Established the “reasonable expectation of income” (gross income, not net profit) test for purpose under 20(1)(c)(i). Confirmed an ancillary income purpose can suffice. Distinguished income from capital gains for this test.
• Singleton v. Canada, 2001 SCC 61: Reinforced the “direct use” test for tracing borrowed funds. Established that transactions should be viewed independently, allowing for properly structured refinancing of personal equity into deductible investment debt.
• Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32: An earlier foundational case often cited for its discussion on the direct versus indirect use of funds and the general principles of interest deductibility.
• Gifford v. Canada, 2004 SCC 15: While primarily an employment expense case concerning the purchase of a client list, it discussed the concept of payments “on account of capital,” which is relevant to the general prohibition in 18(1)(b) and the specific allowance in 20(1)(c).
• Swirsky v. The Queen, 2014 FCA 37 (affirming 2013 TCC 336): Denied interest deduction where there was no reasonable expectation of receiving dividends from privately held shares, even if capital gains were hoped for. Highlights the importance of a genuine income expectation.
• Van Steenis v. The Queen, 2018 TCC 78: Addressed the impact of Return of Capital (ROC) distributions from mutual funds. Confirmed that if ROC is used for personal purposes and not reinvested or used to pay down the loan, the interest deductibility on that portion of the loan is lost.

Wealth advisors should recognize that tax law is dynamic. Legislation is amended, the CRA updates its administrative positions, and courts continuously interpret the law. Therefore, reliance on the Income Tax Act itself, current CRA publications like Folio S3-F6-C1, and an awareness of leading and recent jurisprudence are all essential components of providing competent advice in this area.

12. Conclusion

The deductibility of interest on investment loans is a valuable component of many wealth-building strategies for Canadian investors. However, the rules set out in the Income Tax Act, chiefly under paragraph 20(1)(c), are intricate and subject to ongoing interpretation by the Canada Revenue Agency and the courts. For wealth advisors, a thorough understanding of these rules is not merely beneficial but essential for providing sound, compliant advice.

The core tenets of interest deductibility—the legal obligation to pay interest, the reasonableness of the amount, the critical “purpose of earning income” test (requiring a reasonable expectation of gross taxable income, not solely capital gains), and the meticulous tracing of borrowed funds to a current, eligible use—must be at the forefront of any discussion about leveraged investing. Landmark cases like Ludco and Singleton have provided crucial clarity on purpose and tracing, respectively, while cases like Swirsky and Van Steenis offer important cautions regarding dividend expectations and the management of Return of Capital.

Recent legislative developments, particularly the EIFEL rules (though likely not impacting most typical wealth advisor clients), add another layer of complexity for certain taxpayers. Wealth advisors must also remain vigilant regarding CRA’s evolving administrative positions, as articulated in Income Tax Folio S3-F6-C1 and its periodic updates.

Practically, wealth advisors should prioritize client suitability for leveraged strategies, conduct robust risk assessments, and ensure comprehensive client education on the mechanics and tax implications of borrowing to invest. This includes emphasizing the critical importance of diligent record-keeping to establish a clear audit trail and the proper handling of funds, especially avoiding commingling where possible and correctly managing ROC distributions. Strategies like the Smith Manoeuvre, Immediate Financing Arrangements, and Insured Retirement Plans, while potentially powerful, demand an even higher degree of understanding, precision in execution, and ongoing monitoring to maintain their intended tax benefits and manage associated risks.

By staying abreast of legislative changes, CRA pronouncements, and judicial precedent, and by diligently applying these principles in client interactions, wealth advisors can effectively guide their clients in navigating the complexities of interest deductibility, helping them make informed decisions that align with their financial goals while adhering to Canadian tax law.

As a final step, we encourage you to discuss any specific client scenarios with their qualified tax accountant to ensure all aspects of their unique situation are considered.

For insurance-based leveraging strategies such as Immediate Financing Arrangements, contact Taxevity. We specialize in helping wealth advisors structure these solutions for your clients.

Promod Sharma (FSA, FCIA) and Jeevan Sharma (CFP) YOUR FAMILY TEAM

At Taxevity Insurance, we’re passionate about bringing clarity to complex financial decisions. Let us empower you with personalized strategies to achieve your goals. We focus on life and health insurance solutions to protect your business, your family, and your legacy.