- Canadian income tax law generally allows a deduction for interest paid on borrowed money where that money is used for the purpose of earning income from a business or property.
- Both routes can potentially support an interest deduction, and both can also fail to, depending on facts.
- Many Ontario acquisitions route acquisition debt through a holding company that will, in turn, receive dividends from the operating company it owns.
Almost every financed business purchase raises the same tax question sooner or later: is the interest on the acquisition loan deductible? The honest answer is that it depends — on how the borrowed money is used, who is borrowing it, and what that borrower is expected to earn as a result. This is genuinely technical territory, and it's one of the areas where getting specific advice before you borrow matters more than almost anywhere else in a business purchase.
This article explains the general principle Canadian tax law applies to interest deductibility, and the questions that principle raises once a holding company enters the picture.
The General Principle
Canadian income tax law generally allows a deduction for interest paid on borrowed money where that money is used for the purpose of earning income from a business or property. In plain terms: the tax system is generally comfortable letting you deduct the cost of borrowing when the borrowing itself is aimed at generating taxable income — but it looks closely at what the money was actually used for, not just what the loan documents say, or what asset happened to be purchased around the same time.
This "income-earning purpose" test is well established, but applying it to a specific acquisition loan is fact-specific, and small differences in how a deal is structured can change the answer. Nothing in this article should be treated as a conclusion about how the rule applies to your particular purchase — that requires a tax professional reviewing your actual structure.
Borrowing Personally vs. Borrowing Through a Holdco
| Borrowing personally to buy shares | Borrowing through a holdco | |
|---|---|---|
| What the interest is tested against | Whether the shares can reasonably be expected to produce income (such as dividends) for the individual borrower | Whether the holdco's use of the funds — often re-lending to, or investing in, an operating company — has its own income-earning purpose |
| Common planning goal | Deduct interest against the individual's own income, if the shares are expected to pay dividends | Keep the acquisition debt (and the associated interest deduction) inside a corporate structure alongside the operating business |
| Added complexity | Whether the dividend expectation is more than nominal is itself a fact-specific question | Intercorporate loans, guarantees, and dividend flows from an operating company up to the holdco each need their own analysis |
Both routes can potentially support an interest deduction, and both can also fail to, depending on facts. Which structure is used is a genuine planning decision, not a formality — this is exactly the kind of question to raise with an accountant or tax lawyer before the loan is advanced, not after the fact.
Why the Holdco Route Is So Common in Practice
Many Ontario acquisitions route acquisition debt through a holding company that will, in turn, receive dividends from the operating company it owns. Dividends paid between Canadian corporations that meet certain relationship tests are, in general, not subject to a further layer of corporate income tax — which is part of the reasoning behind placing acquisition debt in a holdco that expects to receive that dividend income. This general area is also subject to anti-avoidance rules that can apply in specific circumstances, so it should never be assumed to work a particular way without a tax advisor confirming it for your actual structure.
What Commonly Complicates the Analysis
- Circular or non-commercial financing arrangements. Structures that don't reflect a genuine economic transaction attract closer scrutiny than straightforward, arm's-length borrowing.
- Mixed use of loan proceeds. If borrowed funds are used partly for an income-earning purpose and partly for something else (paying down personal debt, funding a distribution, etc.), the deductible portion may need to be tracked and apportioned.
- Changes in how the funds are used over time. If the underlying business or investment changes materially after the loan is advanced, the interest deductibility analysis can change along with it.
- Refinancing an existing acquisition loan. Replacing one loan with another doesn't automatically preserve the original deductibility conclusion — the new loan's use needs its own analysis.
None of this is a substitute for planning the structure properly at the outset, with professional advice, rather than trying to justify a deduction after the loan has already been used.
Frequently asked questions
Is interest on a loan to buy shares of a business always deductible?
No. Deductibility depends on whether the borrowed money is used for an income-earning purpose, which is a fact-specific test — it is not automatic just because the money was used to buy shares of an operating business.
Does it matter whether I borrow personally or through a holding company?
Yes, potentially significantly. Each route raises its own version of the income-earning purpose question, and the answer can differ even for what looks like a similar acquisition — this is a key reason to plan the borrowing structure with a tax advisor before closing, not after.
Can I deduct interest on a loan used to buy assets of a business rather than shares?
The same general income-earning purpose principle applies, but the analysis is specific to how the assets are used in an income-earning business or held to produce income — an accountant or tax lawyer needs to review your specific asset purchase to confirm how it applies.
Should my lawyer or my accountant advise on interest deductibility?
Both play a role. Your lawyer typically structures the entities, loan documents, and security; your accountant or a tax lawyer confirms the tax treatment and interest deductibility analysis for your specific facts. These conversations work best when they happen together, before the loan is advanced.
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