TaxMatters@EY - November 2013

Feeling doubtful about your interest? Offsetting deductions may be available

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Aneela Rojo and Maureen De Lisser, Toronto

In this technical interpretation, the CRA confirmed that paid interest, as well as any accrued (but unpaid) interest, on debentures must be reported on a T5 slip on an annual basis. More important, the interpretation reminds taxpayers that a deduction may be available if there is reason to believe the interest may not be paid.

Background

In the scenario provided, a corporation that issued debentures only paid interest for the first half of the year and did not pay the interest owing for the second half of the year, due to inadequate cash flows. The corporation issued T5 slips to its investors, reporting all interest paid and payable in the year, including the unpaid interest. Some of the investors questioned why their T5 slips included the unpaid interest.

CRA response

The CRA confirmed that accrued, but unpaid, interest on a debenture must be reported annually on a T5 slip.

The CRA also highlighted two deductions that may be available to offset the unpaid interest:

  • A reserve for doubtful debts where the accrued interest income is not likely to be paid or reimbursed under a deposit insurance program. Where a reserve is claimed, the reserve amount must be included in income in the following taxation year and a new reserve may be claimed at the end of that following year (provided the required conditions are met).
  • A bad debt deduction, where it is established that the unpaid interest has become uncollectible in the year.

The CRA stated that the onus of proof rests with the taxpayer to verify the appropriateness of a reserve for doubtful debts or a bad debt deduction.

Conclusion

The CRA’s response serves as a useful reminder of how taxpayers may mitigate paying tax on unpaid interest in circumstances where there is some doubt as to its collection. If an investor decides to claim these deductions, they should be fully prepared to substantiate the deduction claimed.