INTEREST DEDUCTIBILITY ON BORROWED FUNDS – MADE SIMPLE (WITH DIVIDENDS AND A DASH OF HUMOUR)
- Monique Verlaan
- Apr 9
- 3 min read
I get asked this one a lot: “If I borrow money to invest in stocks, can I write off the interest on my taxes?” And like a good accountant’s answer to anything... “It depends.”
Let’s break it down in plain English, using CRA’s guidance from Folio S3-F6-C1 (because nothing says fun like quoting the CRA), and focus on how dividend-paying investments fit into the picture.
1. The Famous “Purpose Test” – What’s the Money For?
Before you get too excited about writing off interest, the CRA wants to know one thing: Why did you borrow the money?
To pass the Purpose Test (from the Income Tax Act, Section 20(1)(c)), the funds have to be used to earn income—think dividends from stocks or interest from bonds.
It’s not about what you meant to do. CRA isn’t a mind reader. They’re looking for objective proof that the money went toward something that actually can earn income.
It has to be a reasonable expectation of income. Just holding shares in a company you hope will pay dividends one day doesn’t always cut it—unless there's good reason to expect it.
So if you borrowed money to buy something like dividend-paying stocks? You’re generally in the clear. But if you borrowed to buy Bitcoin hoping it’ll moon? That’s a no-go on the interest deduction.
2. Dividends: The CRA’s Favourite Kind of Investment Income
Here’s where dividend-paying stocks become your best friend.
Dividends = Income. It’s not just theoretical. If you borrow money to buy shares that pay regular dividends, you’re showing the CRA that your investment has income-producing potential.
Growth stocks? Not so much. If the stock doesn’t pay dividends and the only upside is future capital gains, the CRA may say, “Nah, not deductible.” Dividends = good. Capital gains alone = maybe not.
Even if a stock has temporarily suspended dividends (say during tough times), if it has a solid history and a good shot of restarting those payments, CRA may still give you the green light.
3. What If the Dividends Stop?
Uh-oh. The company cuts its dividend. Does that mean you lose your interest deduction? Not necessarily.
Temporary pause? You're probably fine.
Permanent change or you switch to a non-dividend investment? Now we’re talking about a change in purpose, and that could impact deductibility.
If you sell those dividend-paying stocks and use the cash for something else—say a ski trip or a new kitchen—you’ve broken the income-producing chain. Interest deductibility? Gone.
4. Follow the Money – The CRA Sure Will
To claim interest deductibility, you need to trace the borrowed money directly to the investment.
Bought dividend stocks with the loan? Perfect.
Mixed the loan with other stuff like personal spending? Now it's messy. And CRA doesn't like messy.
Best practice: Keep borrowing for investments separate. Open a dedicated investment loan or line of credit, and document everything. (Your future self will thank you at tax time.)
5. Strategies That Help You Nail the Purpose Test
Here are a few examples where dividend-focused investing helps you stay CRA-compliant:
The Smith Manoeuvre: This popular strategy involves converting your mortgage into a tax-deductible investment loan—but only if you’re investing in income-producing assets like dividend stocks or ETFs.
Preferred Shares: These often pay reliable dividends and are usually a safe bet when borrowing to invest.
Dividend Mutual Funds & ETFs: If the fund’s objective is to generate income, and you’ve used borrowed money to invest in it, you're likely in good shape.
Final Takeaway
If you’re borrowing to invest, dividends are your golden ticket when it comes to deducting interest. CRA wants to see a clear purpose: income generation. And dividends provide a steady, measurable way to meet that requirement.
✅ Document everything
✅ Stick to income-producing investments
✅ Keep your borrowed funds clean and traceable
And most importantly... don’t assume CRA is okay with your plan just because it “makes sense” to you. Their version of common sense involves reading tax folios for fun.
Need help sorting it out? Reach out before CRA does 😉
interest deductibility, dividend-paying stocks, CRA purpose test, borrowed funds tax, Anker RETax advice, dividend income, tax savings, investment tax tips, CRA guidelines, dividend strategy
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