May 28, 2021
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Direct use rule

If you borrow money, the interest you pay on the loan is normally deductible if the money is used for the purpose of earning income from a business or property. Income from business is fairly self-explanatory. Income from property includes dividends, rent, and interest income. 

Income from property does not include capital gains. However, if you borrow to buy investments like common shares or equity mutual funds for capital gain purposes and they are capable of paying dividends or other income from property, you can normally still get a full interest deduction.

If you borrow money that is used for personal purposes, the interest is not deductible. For example, if you have a mortgage on your home, the interest on the mortgage is typically not deductible (although a portion may be deductible if you carry on business through a home office – see our June 2020 Tax Letter for details).

In terms of the “use of borrowed money” requirement, the courts have indicated that a direct use of the borrowed money is required, and that an indirect use does not normally qualify. The distinction between a direct and indirect use is shown in the following example.


You have $500,000 in cash to invest. You are considering buying a house but also want to buy some stocks and mutual funds. You need to borrow money to accomplish both types of purchases.

If you borrow to buy the house, the direct use of the loan is not for the purpose of earning income (again, subject to the comment above where you use part of the home in your business). You cannot argue that the loan allowed you to acquire the stocks and mutual funds by freeing up your $500,000 cash to purchase them. Therefore, the interest on the house loan is not deductible because the direct use is to purchase the house, even though the borrowing indirectly allowed you to buy the stocks and mutual funds. 

However, if you take out a loan to buy the stocks and mutual funds, the direct use of the borrowing is for the purpose of earning income. You can then use your $500,000 cash to buy the house. In this case, the interest on the loan would be fully deductible.

A tax planning tip is sometimes called the “interest deduction shuffle”, since it involves using borrowed money directly to buy income investments, while the borrowing indirectly allows you to purchase a personal use property like your home. Some refer to this as the “Singleton shuffle”, after the landmark Supreme Court of Canada decision that gave this type of transaction its blessing.

In Singleton, the taxpayer was a partner at a law firm. He had about $300,000 of capital (cash) invested in the firm. He wanted to buy a home, but he knew if he took out a loan to buy the home, the interest on the loan would not be deductible. Therefore, he withdrew his capital from the law firm to buy the home, and on the same day borrowed $300,000 from a bank to replenish his capital account at the firm. Since the direct use of that borrowing was to invest in his law firm, which was for the purpose of earning income from a business, the Supreme Court held that the interest on his loan was fully deductible. 

And obviously, the Canada Revenue Agency (CRA) must respect decisions of the Supreme Court of Canada.

So let’s look at the Singleton shuffle applied to a variation of the above example. 


You currently own stocks and mutual funds worth $500,000. You want to buy a house and would need to take a $500,000 mortgage loan to buy it. If you do, the interest on the loan will not be deductible.

Instead, you sell the stocks and mutual funds for $500,000 and use those proceeds to buy the home. Then, you borrow $500,000 from a bank – secured by a mortgage on your home − to repurchase the stocks and mutual funds (or any other income-earning investments). Now, the direct use of your borrowing is an income-earning purpose, and the interest on the borrowing is fully deductible. 

From the bank’s point of view, the $500,000 loan to you is just as secure as if it were a mortgage taken out to buy the home, since it’s done as a mortgage.

This transaction works best if the stocks and mutual funds have little or no accrued capital gain, since any accrued taxable capital gain will be triggered when you sell the funds.

Loans for RRSPs and TFSAs

If you take out a loan to invest in your registered retirement savings account (RRSP) or tax-free saving account (TFSA), you seem to be using the loan to invest and earn income from property. So, based on the above rule, you might think you can deduct the interest on the loan.

Unfortunately, there is a specific provision in the Income Tax Act that overrides the above rule and disallows any interest deduction on loans to invest in RRSPs and TFSAs (as well as other tax-deferred plans, like registered pension plans, registered education savings plans and registered disability saving plans).

The rationale for disallowing the interest deduction on these loans is that even though the money is typically used for the purpose of earning income from property, the income earned while in the RRSP or TFSA is not subject to tax (for a TFSA it is also not taxed when you take the money out). Basically, the government is saying that since we are not taxing the income while it’s earned, we are not going to allow you to deduct your interest expense in the meantime.

What happens if you sell the investment at a loss and still owe money?

A potential problem arises if you sell an investment property acquired with a loan, and you subsequently sell the property at a loss. In such case, you might not be able to fully repay the loan. So if some of the loan remains outstanding, can you still deduct the interest expense on the loan? You might think “no”, since you are no longer using the loan for income-earning purposes.

Fortunately, the answer is usually “yes”.

There is a specific provision under the Income Tax Act that basically says that the amount of your loan in excess of the proceeds of disposition of the property (at a loss) is deemed to be used for the purpose of earning income from a property. Therefore, an interest deduction will remain for that portion of the loan. The following is an example.


You took out a $100,000 loan to buy stocks. Unfortunately, the stocks went down significantly in value, and you decided to sell them when they were worth $40,000. 

You use the $40,000 to partially pay off the loan, and therefore you still owe $60,000. Under the specific provision, your interest on the remaining $60,000 principal amount of the loan will remain deductible, even though you no longer own the stocks.

A similar provision applies if you take out a loan that is used in your business, you later cease to carry on the business, and the value of your business properties is less than the principal amount of the loan still outstanding. In general terms, a portion of the loan is allocated to any property that you sell (and for this purpose, there is a deemed disposition once you begin to use the property for any other purpose). The remaining part of the principal amount of the loan, if any, is deemed to be used for the purpose of earning income from a business and the interest expense on that part remains deductible.

This letter summarizes recent tax developments and tax planning opportunities from a third-party affiliate; however, we recommend that you consult with an expert before embarking on any of the suggestions contained in this blog post, which are appropriate to your own specific requirements. Please feel free to get in touch with Lee & Sharpe to discuss anything detailed above, we would be pleased to help.
Adam H. Sharpe

Hello, my name is Adam Sharpe, I am a partner at Lee & Sharpe.

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