Cash damming is a strategy that allows taxpayers to gradually convert personal debt with non-deductible interest into debt for which interest can be deducted.
Who benefits from cash damming?
This strategy is intended primarily for unincorporated self-employed workers. Partners of a general partnership can also use the strategy with a few modifications. Individuals who own rental properties can also consider cash damming.
However, for the time being, salaried employees cannot use this strategy.
How it works
- Open two separate bank accounts (one with a line of credit).
- Deposit all business revenue in one account.
- Pay all business expenses from the account with a line of credit.
- Use business income to cover current expenses and gradually pay off your personal debt.
This means that the interest on the loan (line of credit) used to fund business expenses can be clearly traced for tax purposes.
Cash damming allows you to pay off your personal debt with non-deductible interest as quickly as possible, replacing it with debt (line of credit) that features completely tax-deductible interest.
Business expenses that are not fully deductible (i.e., business promotion expenses) have no impact on the full deductibility of interest on the loan used to fund this type of expense.
The personal income tax (including instalment payments) of a self-employed worker is considered a personal expense, not a business expense. Therefore, they must be paid from gross business revenue and not from the line of credit.
The Income Tax Act dictates that the borrowed amount must be used solely for eligible expenses. Therefore, you must make sure that the line of credit is being used exclusively to pay off business rather than personal expenses.
Are you interested in cash damming?
Given the growing number of tax regulations regarding the taxability of interest, you should check with your accountant or tax expert when it comes to determining eligible expenses.
To find out more about cash damming, don’t hesitate to contact your National Bank advisor.