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Tax Court denies interest deduction to TDL Group based on indirect use of borrowed funds

Tax Court of Canada decision shows that taxpayers must be wary of Canada’s interest deductibility rules when planning related-party loans.

In The TDL Group (TDL) decision rendered in early March 2015, the Tax Court of Canada (the Court) upheld the Minister of National Revenue’s (the Minister) assessment denying TDL a deduction of a substantial amount of interest paid by TDL on a loan received from its direct US parent, Delcan.

Wendy’s International (Wendy’s), a US company, made an interest-bearing loan to Delcan and, in turn, Delcan made an interest-bearing loan to TDL. TDL then used the borrowed funds to subscribe for additional common shares of its US subsidiary, Tim Donut US (Tim US). The next day, Tim US used the subscription funds to make an interest-free loan to Wendy’s.

The discussion in TDL centered on whether the subscription of additional common shares of Tim US met one of the requirements under Canadian interest deductibility rules, namely that the borrowed money be used for an eligible purpose; that is, to earn non-exempt income from a business or property.

The Minister’s position was that the borrowed funds were not used for the purpose of earning non-exempt income, and that TDL’s sole purpose in subscribing for shares of Tim US was to render funds available to Wendy’s interest-free while generating an interest expense for itself. TDL contended that it simply used the proceeds of the loan to acquire common shares of Tim US, and that only TDL’s use of the borrowed funds (rather than the use of such funds by Tim US) should be relevant to the interest deductibility analysis.

After an extensive analysis of the case law and facts, the Court concluded that at the time of the share subscription, TDL did not have “any reasonable expectation of earning non-exempt income of any kind”.

The Court found that at the time of the subscription there was no intention or expectation that Tim US would pay dividends on the shares for at least several years, given Tim US’ history of losses andthe group’s policy of not paying dividends until capital expenditures were funded. The Court further remarked that there was no credible evidence that the funds were to be used by Tim US for any purpose other than to make the interest-free loan to Wendy’s at the time of the subscription.

This case serves as a striking reminder that the indirect use of borrowed funds should be considered in analysing the purpose component of the Canadian interest deductibility rules, even in fairly commonplace transactions such as the acquisition of common shares. Of note is that the original interest-free loan made by Tim US to Wendy’s was assigned to a subsidiary of Tim US and replaced with an interest-bearing loan in the same fiscal year, and the deduction of interest paid by TDL to Delcan starting from such time was not challenged by the Minister.

Hopefully, this case will be limited to its particular facts and not have implications for the deductibility of interest on borrowed money used to acquire common shares in more typical circumstances.

TDL has appealed the decision.

John Leopardi is a partner, and Alexandra Carbone is an associate, at Blake, Cassels & Graydon’s Montréal office. They can be reached at and

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