CRA Rules Applied

This app implements guidance from the Canada Revenue Agency, primarily Income Tax Folio S3-F6-C1, "Interest Deductibility." This page explains the key rules and how the app applies them.

Primary Source

Income Tax Folio S3-F6-C1 is the CRA's comprehensive guidance on interest deductibility. It replaces the older Interpretation Bulletin IT-533 and provides detailed rules for when interest qualifies as a tax deduction.

The Folio is available on the CRA website. Key paragraphs referenced below use the format "¶1.XX" for specific paragraph numbers.

Rule 1: Interest Must Have an Eligible Purpose

The Rule: Interest is deductible under paragraph 20(1)(c) of the Income Tax Act when borrowed money is used for the purpose of earning income from business or property (¶1.1, ¶1.6).

How the App Applies It: The app tracks which borrowed funds are connected to income-producing investments. Only interest on this portion—invested principal plus related capitalized interest—is classified as deductible.

Practical Impact: When you borrow to invest in securities that produce dividends, interest, or capital gains, the interest on that borrowing is deductible. When you borrow for personal use, it's not.

Rule 2: Proportional Repayment Allocation

The Rule: When a single credit account is used for both eligible (investment) and ineligible (personal) purposes, repayments cannot be selectively applied. "The flexible approach described in ¶1.42 cannot be applied to the repayment of borrowed money where a single borrowing account... is used for eligible and ineligible purposes" (¶1.43).

How the App Applies It: When you record a Credit Payment, the principal portion is allocated proportionally across all debt categories—invested, uninvested, personal-use, and capitalized interest. You cannot choose to pay down only the non-deductible portion.

Example: If your debt is 70% deductible and 30% non-deductible, a $1,000 principal payment reduces deductible debt by $700 and non-deductible by $300.

Why This Matters: This rule prevents taxpayers from gaming the system by selectively paying off non-deductible debt first to artificially increase their deductible percentage.

Rule 3: Flexible Tracing for Commingled Funds

The Rule: When borrowed money is commingled with other funds (like personal savings), the taxpayer may choose which funds are used for each purpose. "Where the borrowed money has been commingled with other money... the taxpayer may trace the borrowed money to all of the uses of that money pool and may choose the uses of the borrowed money from all of the uses of the money" (¶1.42).

How the App Applies It: When you buy securities with a mix of borrowed and personal cash, you can specify how much comes from each source. The app defaults to using borrowed cash first (maximizing invested principal), but you can override this.

Example: You have $5,000 borrowed cash and $2,000 personal cash. You buy $4,000 of securities. You can allocate $4,000 from borrowed (leaving $1,000 borrowed and $2,000 personal), or $3,000 borrowed and $1,000 personal, or any other combination up to your available balances.

Why This Matters: This flexibility allows you to maximize the portion of your investments funded by borrowed money, increasing your deductible interest.

Rule 4: Cash-Basis Timing

The Rule: For taxpayers using the cash method (most individuals), interest is deductible when paid, not when it accrues (¶1.13).

How the App Applies It: The app tracks "outstanding interest" (charged but not paid) separately from "paid interest" (actually deductible). Your dashboard shows deductible interest paid, which is what you claim on your tax return.

Example: December's interest charge creates outstanding interest. When you pay it in January, it becomes deductible in the January payment year.

Why This Matters: Tax timing can affect which year you claim deductions. Capitalizing December interest in December makes it deductible that year; paying cash in January defers the deduction.

Rule 5: No Retroactive Attribution

The Rule: Borrowed money cannot be attributed to investments made before the borrowing occurred. "A specific use of money can never be linked to a borrowing that occurs subsequently" (¶1.42).

How the App Applies It: Events are processed chronologically. A security purchase can only use borrowed cash that existed at the time of purchase. You cannot record a purchase on January 10 and fund it with a borrow recorded on January 15.

Example: You buy $5,000 of securities on Monday, then borrow $5,000 on Wednesday. Even though you now have borrowed cash, you cannot retroactively attribute it to Monday's purchase. That purchase must be funded from whatever cash you had on Monday.

Why This Matters: The CRA requires actual tracing of funds. You can't borrow after the fact and claim the earlier purchase was made with borrowed money.

Rule 6: Disappearing Source

The Rule: Interest may continue to be deductible even after the original investment is sold, as long as the debt remains and the original borrowing had an eligible purpose (¶1.44-1.48). However, if proceeds are used for personal purposes, subsequent interest loses deductibility.

How the App Applies It: When you sell securities, the borrowed portion of proceeds returns as borrowed cash (uninvested principal). Interest on this remains potentially deductible while you're holding the cash for reinvestment. If you withdraw it for personal use, it becomes personal-use principal and interest is no longer deductible.

Example: You sell securities that were 100% borrowed-funded. The proceeds go to borrowed cash. If you reinvest within a reasonable time, interest remains deductible. If you withdraw it for a vacation, the debt becomes personal-use.

Why This Matters: This provides flexibility during portfolio rebalancing. You don't immediately lose deductibility when you sell—you have time to reinvest.

Rule 7: Return of Capital Treatment

The Rule: Return of capital reduces the cost base of an investment. When borrowed funds are returned through RoC, the return follows the same proportion as the original investment (implied by tracing principles throughout the Folio).

How the App Applies It: When you receive return of capital, the app calculates the borrowed portion based on your position's borrowed percentage. That portion returns as borrowed cash, reducing your invested principal.

Example: A position is 75% borrowed. A $100 return of capital includes $75 of borrowed capital, which returns as borrowed cash.

Why This Matters: RoC gradually shifts your investments from borrowed to personal funding if not reinvested. The app tracks this accurately.

Rule 8: Interest on Interest

The Rule: Interest paid on money borrowed to pay deductible interest is itself deductible (¶1.38).

How the App Applies It: When you capitalize deductible interest, the new principal (capitalized deductible interest) is itself deductible debt. Interest on that debt is deductible.

Example: You capitalize $100 of deductible interest. Your capitalized deductible interest increases by $100. Future interest charges on that $100 are themselves deductible.

Why This Matters: This supports the Smith Manoeuvre and similar strategies where interest compounds through capitalization.

Areas of Uncertainty

Some areas involve interpretation where the CRA's guidance is less explicit:

Uninvested Principal

The app classifies uninvested principal (borrowed money in your brokerage, not yet invested) as non-deductible by default. This is conservative. The Folio suggests that interest on money borrowed for investment purposes can be deductible while the taxpayer is "actively seeking suitable income-earning assets" (¶1.28).

If you're actively investing, you may have a reasonable position that interest on uninvested principal is deductible. Consult a tax professional and document your investing activity.

Timing and Intent

The CRA focuses on actual use of funds, not just intent. Money borrowed "for investment" that sits indefinitely or is used for other purposes may lose its deductible character. The app tracks timing through dates, but the reasonableness of delays is ultimately a judgment call.

Proportional Allocation Method

The app uses a time-weighted proportional allocation for interest. This is a reasonable and defensible approach, but the Folio doesn't prescribe a specific methodology. Other reasonable methods might produce slightly different results.

Documentation for Audit

If the CRA ever questions your interest deductions, you'll need to demonstrate:

1. Borrowed funds were used for eligible purposes — The app's ledger traces each dollar from borrowing through investment.

1. Interest calculations are reasonable — The app's interval-based calculation is systematic and defensible.

1. You applied rules consistently — The app enforces consistent treatment of all events.

1. You have supporting documents — Keep your actual bank and brokerage statements, loan agreements, and tax slips. The app is a tracking tool, not a replacement for source documents.

Limitations

This app implements common interpretations of CRA guidance for straightforward leveraged investing. It does not cover:

• Complex corporate structures
• Borrowed money used in a business
• Multiple currencies
• Margin loans from brokerages
• Sophisticated tax planning strategies

For complex situations, consult a tax professional who can review your specific circumstances against current CRA guidance and case law.

References

Income Tax Folio S3-F6-C1, Interest Deductibility https://www.canada.ca/en/revenue-agency/services/tax/technical-information/income-tax/income-tax-folios-index/series-3-property-investments-savings-plans/series-3-property-investments-savings-plan-folio-6-interest/income-tax-folio-s3-f6-c1-interest-deductibility.html

Income Tax Act, paragraph 20(1)(c) The statutory basis for interest deductibility.

Previous Interpretation Bulletin IT-533 (archived) Now replaced by S3-F6-C1, but may provide historical context.