Interest deductibility: Australia and Canada compared

During the last decade, the judiciary and policy makers in both Canada and Australia have struggled to define coherent principles pertaining to the deductibility of interest on borrowed funds. Neither jurisdiction has appeared to make reference to the experiences in the other. In both jurisdictions the test prescribed in the legislation is, "were the funds borrowed for the purpose of deriving income?" Each jurisdiction has authority directing this inquiry to the use of the funds and thereby asserting a tracing principle. However, this approach has been flawed in dealing with complex factual scenarios. In Australia subsidiary tests such as the "occasion principle", "the preservation of assets test" and the "refinancing principle" have been embraced by the courts. However, the tests often march in opposing directions leading to considerable uncertainty and irreconcilable authorities. On the other hand, in Canada the judiciary has substantially adhered to the tracing principle but the uncommercial nature of this principle encouraged administrative concessions by Revenue Canada and, more recently, has witnessed the issue of draft legislation. The position now established in both jurisdictions is similar although achieved in a very different manner. However, the Canadian legislative approach is to be preferred given the uncertainty still inherent in the judicial solution in Australia. In drafting legislation, it is the writer's view that no coherent general principle is achievable due to the diversity of potential scenarios. Rather a recognition that certainty will require arbitrary rules generating anomalies and inequities must be appreciated