The federal government may be changing its mind on the issues of interest deductibility and the reasonable expectation of profit.

Last fall, senior tax officials attending the Canadian Tax Foundation’s annual conference assured tax practitioners that the Canada Customs and Revenue Agency will be following recent Supreme Court of Canada decisions about these issues. But in Tuesday’s budget, Ottawa said that “recent court decisions could lead to inappropriate tax results. Neither of these results is consistent with appropriate tax policy. Nor would they have been generally expected under prior law and practice.”

While Finance officials wouldn’t say what changes they will propose to overcome the court decisions, a new rule may be in the offing, which would mandate that net income, instead of gross income, would be required to obtain a deduction.

In one case, known as Ludco v. the Queen, investors wrote off $6 million in interest expenses from monies borrowed to buy offshore shares that resulted in $600,000 in gross income. Despite the jarring gap between the expenses and profit, the SCC allowed the interest deduction. It said such a deduction was permissable as long as one of the purposes of the investment was to make income. It did not have to be the main purpose of the investment.

In a subsequent case, Stewart v. the Queen, the taxpayer was an investor in a heavily leveraged condominium development. There was some income generated — this time from rents — but the discrepancy again caught the CCRA’s attention. The SCC allowed the deduction saying there was a reasonable expectation of profit.

Before finalizing any new proposals, a public consultation process will be conducted by Finance.