The debt-swap above works well when you can sell investments with little or no tax to pay. If you have significant accrued gains, another idea could work without causing a tax hit on the sale of those investments.
Here’s an example: James has $100,000 of non-deductible debt (his home mortgage in this case). He also has a portfolio of investments worth $200,000 with an accrued capital gain of $100,000 (if he were to sell this portfolio it would trigger a tax hit of $23,000 at a marginal tax rate of 46 per cent). James transfers his $200,000 portfolio to his holding company on a tax-deferred basis (using section 85 of the Income Tax Act) and in exchange takes back shares in the holding company worth $100,000 plus a promissory note for $100,000 (there’s a reason for it being $100,000; speak to a tax pro).
James then borrows $100,000 from his bank and uses the cash to subscribe for more shares in his holding company. This use of the borrowed money allows him to deduct the interest on those funds. The company then takes the $100,000 of cash it receives on that subscription of shares and uses the funds to pay off the $100,000 note owing to James. There’s no tax to pay on this repayment of the note. James then takes the $100,000 of cash and pays off his non-deductible debt. In the end, James still has $100,000 of debt, but he’s able to deduct his interest. Now, as a practical matter James may not go to these lengths solely to create an interest deduction, but there may be other good reasons to put investments into a holding company. Speak to a tax pro for more.
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