Reassessment

Following an audit of leveraged acquisition financing and subsequent refinancing transactions, the Canada Revenue Agency reassessed multiple taxation years and denied a portion of the company’s interest deductions.

The Agency did not dispute that funds had been borrowed or that acquisitions had occurred. Instead, it asserted that portions of the borrowing failed the statutory purpose requirement under subsection 20(1)(c) of the Income Tax Act.

The Agency’s reassessment adopted a defined interpretation of how borrowed funds had been deployed across the corporate structure.

Platform

The company operated a Canadian manufacturing platform supplying specialized industrial components to customers across North America.

Growth occurred through acquisitions of smaller manufacturers and complementary product lines. The strategy expanded production capacity, consolidated fragmented suppliers, and increased the company’s ability to serve larger industrial customers.

Those acquisitions were financed through a holding-company structure above the operating entities.

The financing structure included:

• acquisition debt raised at the holding-company level
• advances of borrowed funds into operating subsidiaries
• refinancing transactions as the platform expanded
• interest deductions claimed within the operating group

As the acquisition program progressed and the platform grew, the amount of interest deducted across the structure increased materially.

Dispute

The dispute did not turn on whether funds had been borrowed.

It turned on whether the financing structure satisfied the statutory requirements of subsection 20(1)(c), particularly the connection between borrowed funds and income-producing uses within the operating group.

The parties advanced competing interpretations of the commercial purpose of the borrowing and the deployment of funds following the acquisitions.

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Structural financing disputes under subsection 20(1)(c)

Interest deductibility disputes arising from leveraged acquisitions rarely turn on accounting mechanics alone. They typically involve judgment about the commercial purpose of borrowing, the deployment of funds across a corporate structure, and the relationship between financing and income-producing activity.

In these disputes, the objection stage establishes the statutory and factual record that shapes how the dispute proceeds if the matter advances beyond the Agency’s self-review stage.

Competing Characterizations

Exposure

The reassessment created exposure across several dimensions:

• multi-year denial of interest deductions
• increased taxable income within operating entities
• accruing interest and potential penalties
• implications for refinancing and covenant planning

The reassessment also required management to address questions from the board and audit committee regarding the financing structure and the company’s exposure under subsection 20(1)(c).

Because the company’s acquisition strategy relied on leveraged financing, the dispute had implications beyond tax liability alone. Management needed to ensure that lenders and other stakeholders understood the nature of the dispute and its potential outcomes.

Resolution

Following the reassessment, exposure was evaluated across potential legal outcomes and management aligned internally on the dispute’s scale, exposure range, and strategic posture.

Management also established how the dispute would be explained to the board, audit committee, lenders, and other stakeholders whose financing arrangements could be affected by the reassessment.

The Notice of Objection established the company’s statutory and factual position under subsection 20(1)(c), including the relationship between the borrowing and the operating businesses acquired through the financing structure.

The dispute proceeded with that framework in place.

The reassessment was reduced.

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Further Analysis

From Tax Dispute Inflection Points

• Leveraged Growth and the CRA Reassessment Cycle

• Management's First Explanation in a CRA Dispute

From Tax Dispute Caselaw & Signals

• Where an Interest Deduction Dispute Is Effectively Shaped