CRA rules applied (S3-F6-C1)

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.

Rule 1: Eligible purpose

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 invested principal plus related capitalized interest is classified as deductible. Borrowing for personal use creates non-deductible debt.

Rule 2: Proportional repayment

When a single credit account is used for both eligible and ineligible purposes, repayments cannot be selectively applied (¶1.43). You cannot choose to pay down only the non-deductible portion first.

How the app applies it: Credit payments are allocated proportionally between deductible and non-deductible principal. Within deductible principal, the reduction is further split between invested principal and capitalized deductible interest. See Mixed HELOC use.

Rule 3: Flexible tracing for commingled funds

When borrowed money is commingled with other funds, the taxpayer may choose which funds are used for each purpose (¶1.42). This provides flexibility when buying securities with a mix of borrowed and personal cash.

How the app applies it: When you buy securities with a mix of borrowed and personal cash, the app defaults to using borrowed cash first (maximizing invested principal). You can override this allocation.

Rule 4: Cash-basis timing

For 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 — the number for your tax return. See Interest capitalization for how capitalizing affects timing.

Rule 5: No retroactive attribution

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 purchase can only use borrowed cash that existed at the time of purchase.

Rule 6: Disappearing source

When an investment purchased with borrowed money declines in value and is sold at a loss, the borrower can't fully recover the borrowed capital. Section 20.1 of the Act (described in ¶1.41) provides that — under specific conditions — interest on the unrecovered portion may continue to be deductible even though the source of income has disappeared.

How the app applies it: When you sell at a loss, the unrecovered borrowed capital (the difference between what you borrowed and what you got back) remains as deductible invested principal. The debt doesn't lose its deductible character just because the investment lost value.

Rule 7: Return of capital treatment

When borrowed funds are returned through Return of Capital, the return follows the same proportion as the original investment.

How the app applies it: RoC reduces the borrowed portion of cost base proportionally, and the returned borrowed capital becomes non-deductible principal.

Rule 8: Interest on interest

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 is classified as capitalized deductible interest. Future interest on that principal is deductible.

Areas of uncertainty

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

Idle borrowed cash: The app classifies idle borrowed cash conservatively as non-deductible. The CRA's position on borrowed money that is temporarily not deployed is not explicitly addressed in the Folio. A reasonable argument can be made that interest remains deductible during a short transitional period while the taxpayer is actively working to deploy the funds, but this is a gray area. Consult a tax professional.
Allocation methodology: The app uses a time-weighted proportional allocation. The Folio doesn't prescribe a specific method, but this approach is reasonable and defensible.
Timing and intent: The CRA focuses on actual use, not just intent. Money borrowed “for investment” that sits indefinitely may lose its deductible character. The app tracks timing, but reasonableness is ultimately a judgment call.

Documentation for audit

If the CRA questions your interest deductions, you need to demonstrate that borrowed funds were used for eligible purposes, calculations are reasonable and consistent, and you have supporting source documents (bank and brokerage statements, loan agreements, tax slips). The app provides the tracking and calculation trail — but keep your original documents as well.

References

Income Tax Folio S3-F6-C1 — the CRA's comprehensive guidance on interest deductibility
Income Tax Act, paragraph 20(1)(c) — the statutory basis for interest deductibility