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Income Tax Audit Manual

Compliance Programs Branch (CPB)

Information

This chapter was last updated November 2022

Chapter 24 - This chapter is under review and an updated version will be released at a later date

Disclaimer

To avoid renumbering cross-referenced material, when it has become necessary to delete or relocate information in the manual, the section or chapter has been marked as "for future use" or "section removed."

Hyperlinks to external or unaffiliated websites are for information purposes only. The Canada Revenue Agency (CRA) is not responsible for the content or practices of such websites. While efforts are made to ensure that hyperlinks are current and up-to-date, it is not guaranteed.

Chapter 24.0 Transactions involving related persons, corporations and shareholders, dividends, etc.

Table of contents

24.10.0 Benefits conferred on shareholders

24.10.1 Introduction

Shareholders may be in a position to profit from their relationship with a corporation by receiving personal advantages in the form of "benefits" from the corporation. The Income Tax Act (ITA) does not define a "benefit" conferred on a shareholder. In Vine et al. v the Queen, 1989 (FCTD) 89 DTC 5528, the definition used was a "benefit refers to monetary amounts received from the corporation by the shareholder and not the shareholder's overall financial or physical well-being."

Here are some examples of benefits:

Under subsection 15(1) of the ITA, the amount or value of a benefit conferred on a shareholder, or on a person in contemplation of becoming a shareholder, by a corporation in a tax year is included in the shareholder's income for the year, except to the extent that the benefit is deemed by section 84 to be a dividend. The auditor must:

Read this subchapter together with Income Tax Interpretation Bulletin IT432R2, Benefits Conferred on Shareholders.

24.10.2 Income tax implications

General comments

Subsection 15(1) of the ITA generally applies when a corporation confers a benefit on a shareholder. The value of the benefit, other than that set out in the exceptions, must be included in computing the shareholder's income in the year the shareholder received the benefit, or had the right to the property that constituted the benefit, except to the extent that the benefit is deemed by section 84 to be a dividend. The benefit is to be assessed as income from property.

Subsection 15(1) prevents benefits from flowing to shareholders without the appropriate payment of tax. The benefits are not deductible by the corporation and are similar to dividends.

Subsection 15(7) confirms that subsection 15(1) applies to a resident shareholder of a non-resident corporation, whether or not the corporation was resident in Canada or carried on business in Canada.

Meaning of "confer"

For subsection 15(1) to apply, a benefit must have been "conferred" on a "shareholder." It does not apply if the benefit was conferred on a taxpayer in the capacity as a customer, vendor, or employee of the corporation.

"Confer" means to grant or to bestow. For the benefit to be included in the shareholder's income under subsection 15(1), the shareholder must have been aware that the benefit had been conferred or the corporation must have intended to confer the benefit. Determining whether the corporation had intended to confer a benefit on the shareholder is a question of fact.

This means if a shareholder is not aware of the benefit, subsection 15(1) cannot apply. For example, in The Queen v Chopp, 1998 (FCA) 98 DTC 6014, the Federal Court of Appeal (FCA) refused to overturn the lower court's finding of fact that the circumstances surrounding the transaction indicated an innocent accounting error that should not lead to tax. However, the court agreed that, in interpreting the ITA, a benefit can be conferred on a shareholder without the corporation or the shareholder intending to do so, or being aware of the fact, if the following two conditions are met:

1.     The circumstances are such that the corporation or shareholder "ought to have known" that a benefit was conferred.

2.     The corporation or shareholder did nothing to rectify the conferring of the benefit.

While the burden of proof is on the taxpayer to prove that a reassessment is incorrect, only when the facts clearly show the parties in question knew or "ought to have known" that a benefit had been conferred, should the income be reassessed under subsection 15(1). To determine whether one of the parties "ought to have known" that a benefit had been conferred, consider the size of the benefit in relation to the corporation's revenues, expenses, or shareholder loan account.

The Franklin case

Include a review of the Franklin decision to determine whether a benefit is considered to have been conferred on a shareholder.

Facts of Franklin:

  1. The taxpayer was a shareholder of the corporation Homeguard Video Systems Ltd. (HVSL). HVSL purchased a condominium unit (the "Unit").
  2. All monies required by HVSL to acquire the Unit were advanced to the corporation by the taxpayer out of their personal resources (including a personal line of credit). The advances were reflected in the corporation's financial statements as a credit to the shareholder loan account.
  3. Shortly after acquiring the Unit, HVSL sold an undivided 50% interest of it to an arm's length third party for about $59,000.
  4. Of this amount, about $21,399 was deposited to the taxpayer's personal bank account and $22,400 was used to pay off their personal line of credit.
  5. The sale was not recorded in the financial statements of HVSL, nor was the shareholder loan account reduced to reflect the funds received by the taxpayer. The shareholder loan account at that time had a credit balance of about $154,000.
  6. The taxpayer was assessed a subsection 15(1) benefit for the proceeds they received from the sale.

Franklin et al. v The Queen, 2000 (TCC), 2000 DTC 2455

The Tax Court concluded that even though the taxpayer had deliberately failed to report the transaction, no benefit had been conferred on the taxpayer as contemplated by subsection 15(1). The basis for the Court's decision was that a series of bookkeeping errors occurred, which were caused by the taxpayer on purpose or inadvertently, none of which gave the taxpayer any identified benefit. The Court also found that the taxpayer had not withdrawn any money from the corporation in excess of the credit balance in their shareholder loan account, nor was there any evidence that the taxpayer used the incorrect financial statements to obtain a benefit elsewhere for themself.

The Queen v Franklin, 2002 FCA 38

The decision at the Federal Court of Appeal (FCA) was split. The majority agreed with the Tax Court's finding that there was no benefit conferred on the taxpayer according to subsection 15(1). The FCA agreed with the Tax Court's assessment of facts. However, the judge went on to say: "…this judgment is not to be interpreted as condoning taxpayers negligently keeping inaccurate records or deliberately not disclosing transactions."

Go to 24.10.4 section, Application of subsection 15(1) – Credit balance in the shareholder loan account, which discusses the Canada Revenue Agency (CRA)'s guidelines for reassessing shareholder benefits under subsection 15(1) as a result of the Franklin decision.

Shareholder or person "in contemplation" of becoming a shareholder

A benefit may be included under subsection 15(1) if the person was not a shareholder, but was intending to become a shareholder. The expression "in contemplation" means to be in a position to, to be on the point of. This expression is aimed at preventing a person from avoiding subsection 15(1) by simply choosing the right moment to become a shareholder. As long as the person had the intent of becoming a shareholder, subsection 15(1) may apply.

Subsection 15(1) was amended in conjunction with the introduction of subsection 15(1.4) for benefits conferred after October 30, 2011. Subsection 15(1.4) expands on the meaning of a contemplated shareholder to include certain members of a partnership. Subsection 15(1.4) also applies to benefits conferred on an individual who does not deal at arm's length with, or is affiliated with, a shareholder of the corporation.

Subsection 15(1.4)

Subsection 15(1) applies where a benefit is conferred by a corporation on a shareholder or a person contemplating becoming a shareholder. Paragraph 15(1.4)(a) clarifies that subsection 15(1) also applies to a member of a partnership in contemplation of the partnership becoming a shareholder of the corporation. This amendment means that subsection 15(1) now treats persons and partnerships in the same way.

Paragraph 15(1.4)(b) provides a partnership look-through rule to establish who is a member of a partnership that is a shareholder or contemplated shareholder of a corporation. Specifically, the paragraph provides that a "person or partnership" that is a member of a particular partnership that is a member of another partnership, is deemed to be a member of the other partnership.

Previously, subsection 15(1) applied only to shareholders or contemplated shareholders of corporations. Paragraph 15(1.4)(c) expands the meaning of shareholder or contemplated shareholder to include an individual who does not deal at arm's length with, or who is affiliated with, a shareholder or a contemplated shareholder of the corporation. Paragraph 15(1.4)(c) also applies to a member of a partnership that is a shareholder of the corporation or a contemplated shareholder of the corporation. Therefore when a corporation conferred a benefit to the non-arm's length or affiliated individual (such as the spouse) of either a shareholder, a member of a partnership or a contemplated shareholder, subsection 15(1) will apply to the shareholder, the member of the partnership or the contemplated shareholder, as the case may be.

Paragraph 15(1.4)(c) does not apply to the extent that the benefit is conferred on an individual who is required to include the value of the benefit in computing the income of the individual or any other person. However, this exception does not apply if the individual is an excluded trust as defined in paragraph 15(1.4)(d).

Paragraph 15(1.4)(e) deems a non-resident corporation to have conferred a benefit on its shareholder, in certain situations, where the non-resident corporation underwent a specific type of corporate reorganization under the laws of the foreign jurisdiction.

Paragraphs 15(1.4)(a) to (d) apply in respect of benefits conferred on or after October 31, 2011. Paragraph 15(1.4)(e) applies in respect of corporate reorganizations of non-resident corporations that occur on or after October 24, 2012.

Exceptions to the application of subsection 15(1)

If a transaction involving a corporation and a shareholder is a bona fide business transaction, there is no benefit conferred to the shareholder under subsection 15(1). Normally, a transaction is considered to be bona fide when the terms and conditions are essentially the same as they would be if parties dealing at arm's length entered into the transaction.

A shareholder benefit cannot be included in income under subsection 15(1) if it falls within any of the exceptions described in paragraphs 15(1)(a) to (d). For more information, go to paragraph two of Income Tax Interpretation Bulletin IT432R2, Benefits Conferred on Shareholders.

Benefits - Non-resident shareholders

The tax treatment of a benefit conferred on a non-resident shareholder who is also an employee depends on whether the person received the benefit in their capacity as a shareholder or an employee.

When the non-resident shareholder receives an amount or a benefit in the shareholder's capacity as an employee, subsection 2(3) of the ITA applies. When the non-resident shareholder receives an amount or a benefit in the role of a shareholder, paragraph 214(3)(a) deems such an amount to be a dividend to which the normal non-resident tax rules under Part XIII of the ITA apply. In this case, the auditor must confirm with the Non-Resident Section that the applicable procedure has been followed.

Determining the amount or value of the benefit

The taxable value of the benefit calculated for the purposes of subsection 15(1) can be determined in two ways:

1.     based on the expenses and the purchase price of a property that the corporation did not use to produce income from a business or property

2.     based on the FMV of the property or benefit conferred on the shareholder

For 1996 and the subsequent tax years, if the cost of purchasing or leasing a property or service is used to determine the amount of the benefit under subsection 15(1), that cost shall include any tax payable (for example, goods and services tax/harmonized sales tax (GST/HST), provincial sales tax (PST), luxury tax) on the property or service. Before 1996, the GST/HST was calculated separately.

Forgiveness of shareholder debt

Subsection 15(1.2) of the ITA says that the subsection 15(1) amount from the settlement or extinguishment of a loan or other obligation issued by a debtor is the "forgiven amount," as defined in subsection 15(1.21). The "forgiven amount" is the amount of the outstanding obligation that was settled, less the amount paid by the shareholder on the settlement of the obligation, and less the amount included in the shareholder's income at the time the obligation arose.

If a forgiven amount is included as a benefit under subsection 15(1), the rules on debt forgiveness under section 80 do not apply to the debt's principal.

24.10.3 For future use

24.10.4 Audit issues

Interrelationship of subsection 15(1) and paragraph 6(1)(a)

If a benefit is conferred on a shareholder who is also an officer or an employee of the corporation, it is necessary to determine the facts of whether the benefit was received by the taxpayer in the role of a shareholder or an employee. If it was received as a shareholder, subsection 15(1) applies and subsection 18(1) does not allow a deduction to the corporation. If it was received as an employee, paragraph 6(1)(a) applies. In this case, the amount of the benefit is allowed as a deduction to the corporation if the amount is reasonable.

If a corporation continues charging payments on behalf of a shareholder-employee’s payments to its expense accounts after having been informed that it is improper, such action will indicate that the benefits were received in that person's capacity as a shareholder. The benefits will be taxable under subsection 15(1).

Benefits unrelated to the corporation's normal activities

Subsection 15(1) will also apply to payments, appropriations, benefits, or advantages for the shareholder, which are not related to the normal operations of the business. These could include the purchase of clothing and other personal items for the shareholder and family and the forgiveness of a debt owing by the shareholder to the corporation.

Benefits related to the corporation's business activities

Benefits made to a shareholder who is also an officer or employee, which relate to the business activities of the corporation or can reasonably be viewed as additional salary, will be taxed under paragraph 6(1)(a).These expenses could include such items as promotion and entertainment outlays and the payment of the expenses of the shareholder-employee's spouse or common-law partner at a business convention.

Go to:

If an amount is treated by a corporation as wages to a shareholder-employee, regardless of the actual payee of the amount, the CRA will consider it to be wages to that employee. Therefore, if an amount is paid to a third party on behalf of the shareholder-employee, and the corporation treats the amount as wages, the CRA will not assess a subsection 15(1) benefit for that amount. However, source deductions must be made and the amount must be included on the individual’s T4 slip.

In what capacity did the shareholder-employee receive a benefit?

The auditor needs to determine if the shareholder received the benefit as a shareholder or as an employee. Consider these factors:

Go to Bernstein v MNR, 77 DTC 5187 (FCA) for the factors to consider.

Doubtful cases

If there is a genuine doubt as to the capacity in which a shareholder-employee received a benefit, the amount may be taxed under paragraph 6(1)(a). Some of the factors that would justify this treatment include:

Document review

The auditor should review these documents:

Corporate deduction – Voluntary disclosures

As a rule, no deduction will be allowed to the corporation in respect of an amount included in the income of a shareholder under subsection 15(1) of the ITA.

However, when the corporation is controlled by persons with whom the current owners deal at arm’s length, the corporation is permitted to deduct the amount of the benefit or appropriation when these criteria are met:

Reimbursement policy

The general rule is that a reimbursement by a shareholder of an amount taxable under subsection 15(1) will not be allowed as a deduction to the shareholder.

It is the CRA's policy that the shareholder should be offered the opportunity to reimburse the corporation for the amount that would otherwise be assessable under subsection 15(1) if:

In these cases, the shareholder must make repayment without delay by a payment to the corporation or an offset against a liability of the corporation to the shareholder. If this liability is less than the subsection 15(1) amount, the difference must be made up by cash or its equivalent. If this is allowed, it is assumed that the corporation acted as the shareholder's agent in paying the amount in question. If the adjustment of the loan account results in a debit balance at the transaction or subsequent date, subsection 15(2) or subsection 80.4(2) should be applied, as appropriate. The policy can still be applied if the shareholder does not have the cash and makes other arrangements to repay.

The taxpayer should be informed when the repayment can be allowed as a deduction.

If a reimbursement is approved, both the shareholder and the corporation must agree in writing to this arrangement and to the completion of all appropriate entries in the records of the company. A copy of this written agreement must be submitted to the CRA.

Whatever decision is reached, include a full explanation of the decision in the Audit Report.

Price adjustment clauses

If property is transferred in a non-arm’s length transaction, the parties sometimes include a price adjustment clause in the agreement stating that if the CRA determines that the FMV of the property is different than the price determined in the agreement, that price will be adjusted to take into account the excess or shortfall. The CRA will recognize that agreement in computing the income of all parties, provided that all of these following conditions are met:

a. The agreement reflects a bona fide intention of the parties to transfer the property at FMV. When the difference between the FMV is significant, it may indicate that the taxpayers did not make a real effort to determine the FMV of the property. What constitutes a significant difference must be determined on a case–by–case basis.

b. The FMV for the purposes of the price adjustment clause must be determined by a fair and reasonable method. The taxpayer’s reliance on a different valuation method than the one chosen by the CRA and the relative inaccuracy of a FMV determination done in good faith will not, in and of itself, compromise the effectiveness of the price adjustment clause. The determination does not have to be completed by a valuation expert. The issue as to whether or not the parties have used a fair and reasonable method to determine the FMV of a property is a question that must be resolved with a complete examination of all the relevant facts. It is not sufficient to rely upon a generally accepted valuation method. It is also necessary that the valuation method be properly applied having regard to all the circumstances.

c. The parties agree that if the FMV determined by the CRA differs from their valuation, they will use the value determined by the CRA.

d. The excess or shortfall in price is actually refunded or paid, or a legal liability therefore is adjusted.

If all of these conditions are met, the CRA will not apply subsection 15(1) to tax a benefit to shareholders. When the facts in a case show that the parties never intended to complete the transaction at FMV, the price the parties agreed to will not be adjusted and the benefit will be taxable even if the agreement contains a price adjustment clause. In Guilder News Company (1963) Ltd. et al. v MNR  (73 DTC 5048) and Elias et al. v The Queen (97 DTC 1188), the courts recognized the fact that a reasonable effort had not been made to establish FMVs.

In recognizing the price adjustment clause, appropriate adjustments in computing the income of all parties to the agreement will be made in their tax years in which the property was transferred. If the purchaser has filed returns and claimed capital cost allowance, deductions from income based on cumulative eligible capital, or exploration and development expenses for the property for tax years subsequent to that in which it was transferred, any necessary adjustments will be made in those subsequent years. Likewise, any reserves claimed by the vendor to defer the reporting of income will be adjusted.

For more information, go to Income Tax Folio S4-F3-C1, Price Adjustment Clauses. Business Equity Valuation and Real Estate Appraisal are available to discuss with auditors whether a reasonable effort has been made and whether the approach taken is fair and reasonable. You can make a referral to the appropriate section.

Application of subsection 15(1) – Credit balance in the shareholder loan account

CRA audit policy prior to Franklin

Prior to the Franklin decision (for more details about the Franklin case, go to 24.10.2 section, Meaning of "confer"), it was the CRA's position to apply subsection 15(1) if a corporation paid for a shareholder's personal expenditures or when a shareholder appropriated corporate funds. This was done even if the shareholder loan account was in a credit balance, if the benefit was conferred with the knowledge or consent of the shareholder, or if it was reasonable to conclude that the shareholder ought to have known about the benefit.

Also prior to Franklin, it was possible to offset the shareholder benefit when a reimbursement was made by the shareholder or a credit was posted to the shareholder loan account in error. As indicated in the section, Reimbursement policy, a reimbursement by a shareholder of an amount taxable under subsection 15(1) will not be allowed as a deduction, except if:

In such cases, the shareholder may make a payment to the corporation or is allowed an offset against a liability of the corporation to the shareholder. If a reimbursement is requested and granted, both the shareholder and the corporation must agree in writing to this arrangement and to the completion of all appropriate entries in the records of the company. A copy of this written agreement must be submitted to the CRA.

If an amount has been credited to the shareholder loan account as a result of an honest error and the shareholder has not benefited from that error by drawing down on the shareholder loan account, the entry may be corrected (reversed) in the corporate records. The auditor must obtain from the corporation, a copy of the entries required to reverse the credit in the shareholder loan account.

Impact of the Franklin decision on audit policy

The CRA is of the view that the Franklin case was decided on its own facts. It should not be considered as a general rule that a shareholder credit balance must be applied to offset a potential subsection 15(1) benefit. Therefore, the Franklin case should only apply to situations with identical circumstances; the Franklin decision does not impact the CRA's reimbursement position stated above.

The CRA's position is to continue to follow the existing policy concerning the application of subsection 15(1). Auditors must distinguish the facts of the particular case from those of Franklin. A strong factual case needs to be made that a benefit has been conferred. This could be supported by such audit evidence as, for example:

Documentation of the facts and the auditor’s conclusions are very important. Take steps to verify the validity of any credit balance in the shareholder loan account.

Credits posted to the shareholder loan account

A benefit is generally conferred on a shareholder at the time a corporation becomes indebted to the shareholder for nil or inadequate consideration (go to Kennedy v MNR, 73 DTC 5359). However, the auditor must look beyond the journal entry to determine whether a benefit occurred or not. In Bérubé v The Queen, [1994] 1 CTC 2655, Judge Kempo, said:

"… accounting entries reflect rather than create reality, and that a mere bookkeeping entry in a shareholder loan account does not in and of itself constitute a taxable benefit without something more. …"

To determine whether a benefit was conferred, the auditor must decide if the credit posted to the shareholder's account represents:

Genuine transaction or error

Subsection 15(1) does not apply when a credit to the shareholder's loan account was made in these circumstances:

If an amount has been credited to the shareholder loan account as a result of an "honest error" and the shareholder has not benefited from that error by drawing down on the shareholder loan account, the entry may be corrected (reversed) in the corporate records. Obtain from the corporation, a copy of the entries required to reverse the credit in the shareholder loan account. For the application of subsections 15(2) and 80.4(2), the correcting entry will be considered to be effective on the date of the original entry.

Opening credit balance

There is no authority, legislatively in the ITA, or administratively, for CRA auditors to adjust an opening balance in a shareholder loan account. Similar to other balance sheet accounts, CRA auditors do not adjust opening financial statement accounts of taxpayers nor do they create journal entries to change such balances. If auditors determine there are unsupported adjustments (such as journal entries) to the shareholder loan account during the year under audit, an upward or downward audit adjustment may be necessary. However, an auditor does not create an audit adjustment to change the opening balance. If a taxpayer makes a request to change this balance with sufficient support, and has provided proof that adjusting journal entries have been entered into their books and records, the auditor may accept a change to the shareholder loan account balance and update Cortax.

If there is evidence to suggest the opening balance is overstated as a result of a misrepresentation attributable to neglect, carelessness, or wilful default, an adjustment may be considered pursuant to subsection 152(4) of the ITA. However, the onus is on the CRA to prove that the misrepresentation occurred, which may be difficult as entries in the account may have been recorded many years earlier, for which no support or documentation exists. Further, it is a question of fact whether a benefit was actually conferred at the time the indebtedness was recorded (per Kennedy v MNR, 73 DTC 5359).

If a subsequent withdrawal or use of the funds in the account is made in a year under audit, where a pre-existing credit balance in the shareholder loan account exists, the taxpayer will be required to support the balance to the extent of the funds withdrawn. Otherwise, a shareholder benefit or appropriation may be considered. If the auditor has determined that no benefit occurred at the time the indebtedness was recorded or that a decision is made to not assess a benefit but there is still some doubt as the reliability of the balance in the shareholder loan account, the case should be considered for follow up.

Compensation, interest, rent, or dividend

A credit entry to the shareholder’s loan account relating to compensation, interest, or rent generally is a debt that may have been created for consideration of equal value and is not a benefit under subsection 15(1).

Compensation, interest (in certain cases), and dividends are taxable under section 5, paragraph 12(1)(c), and subsection 82(1) respectively, only when they are received. The amounts are considered to have been received if the credit entry made to the shareholder loan account reduces a debit balance (go to The Queen v Ans, 83 DTC 5038 (FCTD)).

Examples

Example 1

Bonus or salaries     $1,000

Shareholder loans                $1,000

Comments

Whether the amount was paid is a question of fact. A bonus or salary means withholdings for Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) contributions/employment insurance (EI) contributions/income tax are deducted and remitted to CRA. This is strong audit evidence that an amount has been paid.

Example 2

Interest                     $1,000 

Shareholder loans               $1,000

Comments

If the shareholder loan accrues interest (normally shown in written agreement), then subsection 12(11) includes the loan in the definition of “investment contract.” If the shareholder includes this as income under paragraph 12(1)(c) on the yearly anniversary of the loan as per subsection 12(4), then the corporation would be allowed a deduction under paragraph 20(1)(c).

Example 3

Rent for a home office      $1,000

Shareholder loans                          $1,000

Comments

The shareholder pays tax on the gross amount of rent, unless the activity is a commercial activity giving rise to a source of income, which would allow the shareholder to claim reasonable expenses. Reasonable expenses involve the part of the residence that is used for business.

The corporation may deduct the rent expense if it is reasonable in the circumstances. If the corporation already has its own offices away from the shareholder's residence, the rent expense may be disallowed under section 67 of the ITA.

The restriction on work space in the home expenses in subsection 18(12) of the ITA does not apply to the corporation, as it is available only to individuals.

Example 4

Dividend                   $1,000

Shareholder loans               $1,000

Comments

Under subsection 82(1) of the ITA, the dividend is included in computing a taxpayer's income when it is received.

Examples of other credit entries which may give rise to benefits

Example 1

Entertainment and travel     $1,000

Shareholder loans                               $1,000

Comments

This entry may represent a shareholder's personal expenses. If this is the case:

However, no adjustment to the corporation and the shareholder's incomes are necessary if the expenses were incurred to earn business income.

Example 2

Bank                           $1,000

Shareholder loans                $1,000

Comments

This entry may represent a deposit of business revenue to the corporation's bank account. If this is the case:

Example 3

Building                     $400,000

Shareholder loans                    $400,000

Comments

This entry may represent the price of a building the shareholder sold to the corporation for more than the building's FMV. If this is the case:

Case law

There is considerable case law dealing with credits posted to the shareholder loan account, including this useful reading:

Suppressed income of the corporation

Income suppressed by a corporation and appropriated by a shareholder will be taxed in that person's hands under subsection 15(1) of the ITA even though the funds may have been loaned back to the corporation or used to repay a shareholder's debt to the corporation.

The amount subject to tax and penalty will be reduced by any reimbursement to the corporation as long as the repayment is in accordance with the CRA's policy on voluntary disclosure.

As this represents income to the corporation, whether or not the shareholder pays the money back, the corporation will still be reassessed for the amount of income not previously recorded.

Penalties

Consider applying penalties under subsection 163(2) against the corporation, the shareholder, or both, particularly for repeated non-compliance. The guidelines in 28.4.0 must be followed in determining whether a penalty applies. If a penalty is not being applied, the corporation and the shareholder must be informed in writing that a recurrence of the events could result in a penalty to either or both of them.

In addition, because reassessments under subsection 15(1) sometimes involve the disposition of property resulting in capital gains, the auditor must consider whether subsection 110.6(6) of the ITA applies to the transaction. Subsection 110.6(6) denies a capital gains deduction if an individual has realized a capital gain on the disposition of capital property (this provision applies to "qualified farm property" and "qualified small business corporation shares") in a tax year and "knowingly or under circumstances amounting to gross negligence" does not report the disposition on the return for that year or does not file a return for that year within one year after the due date. The burden of proof is on CRA to justify the denial of the deduction.

24.10.5 Sale of property by a corporation to a shareholder

General comments

A corporation confers a benefit on a shareholder when it sells capital property to the shareholder for less than its FMV. The value of the benefit is any excess of the FMV of the property over the selling price. The benefit is usually taxable in the year the sale takes place.

The FMV of the property is determined as of the date the transaction takes place. Depending on the nature of the property, refer valuation questions to Real Estate Appraisal or Business Equity Valuation, as necessary.

Go to 24.10.6, if the property sold comes from the corporation's inventory.

Income tax implications - Shareholder

When the shareholder acquires capital property from a corporation for an amount less than the FMV, the auditor must consider the following tax implications:

On occasion, these transfers contain price adjustment clauses. Go to Income Tax Folio S4-F3-C1, Price Adjustment Clauses, for comments about their effect on the application of subsection 15(1).

If the amount of an appropriation is related entirely to a question of valuation, the CRA's policy on reimbursement must be considered. (Go to 24.10.4 section, Reimbursement policy.)

Adjustment to the adjusted cost base of the shareholder's acquired property

For capital gains purposes, any amount included in a shareholder's income pursuant to subsection 15(1) following the acquisition of capital property is added to the property's cost base under subsection 52(1). This does not apply when the property the shareholder acquired is inventory or an eligible capital property.

Adjustment to the capital cost of the shareholder's acquired property

If the price adjustment clause is accepted, then the shareholder's capital cost of the property is the amount actually paid.

To determine the capital cost for section 13 or paragraph 20(1)(a), subparagraphs 13(7)(e)(ii) and (iii) describe two scenarios. If the cost to the corporation is greater than to the shareholder, then the shareholder’s cost is deemed to be the higher amount AND the difference between the two is deemed to be capital cost allowance (CCA) under paragraph 20(1)(a) taken in previous periods. If the cost to the shareholder is greater than to the corporation, then ½ the difference is added to the shareholder’s cost. (Essentially the gain that the corporation should report, if that was the only asset in the pool.)

The rules set out in subsection 52(1) do not affect the capital cost for CCA purposes.

Income tax implications - Corporation

When the corporation sells capital property to a shareholder, the auditor must consider the:

The proceeds of disposition for the purposes of computing the capital gain (loss) may be different than the agreed upon sale price between the parties. When the corporation disposes of a property for a price below its FMV to a shareholder:

Leaseback of property sold by the corporation

In some cases, the sales contract calls for the property to be leased back to the corporation. As a sale-lease back agreement involves two separate transactions (sale of property to the lessor and the subsequent lease of the property to the original owner), the existence of the lease arrangement will usually have no significant bearing on the amount of the appropriation. This can be so even if the rental proceeds may be considerably less than the FMV rental. However, view the transactions as one, unless there is tax avoidance. CRA reimbursement policy applies to rents.

24.10.6 Inventory transferred from a corporation to a shareholder

A benefit is conferred on a shareholder under subsection 15(1) of the ITA when property from a corporation's inventory is sold to a shareholder for proceeds less than FMV.

Fair market value of inventory

To determine the FMV of inventory, the auditor must consider:

1. the property's inherent costs paid by the corporation; or 

2. the property's total FMV reduced by the value of the shareholder's inputs

If the FMV of individual inventory items is significant, consider a referral to Real Estate Appraisal.

Income tax implications - Shareholder

The value of the benefit conferred on a shareholder is the difference, if any, between the FMV of the inventory and the amount the shareholder paid, if applicable. The GST/HST must be added to the benefit according to subsection 15(1.3) when the inventory is not a tax-exempt or zero-rated supply.

Income tax implications - Corporation

The disposition of inventory results in business income, which is taxable under section 9.

When the corporation sells inventory to a shareholder for less than FMV, subsection 69(4) may apply. In this case, the corporation is deemed to have disposed of the property for proceeds of disposition equal to its FMV at that time. For the purposes of subsection 69(4) and administratively for purposes of subsection 15(1), FMV will be determined to be the corporation's replacement cost in most situations.

24.10.7 Theft or embezzlement by a shareholder

General comments

In paragraph 8 of Income Tax Interpretation Bulletin IT432R2, Benefits Conferred on Shareholders , the word "benefit," used in subsection 15(1) of the ITA, has a meaning wide enough to include funds or property of a corporation stolen or embezzled by a shareholder. However, subsection 15(1) requires not only that there be a benefit to the shareholder, but also that it be conferred on the shareholder by the corporation.

If the shareholder and the corporation are not dealing at arm's length, the CRA assumes that any theft or embezzlement of corporate funds or property by the shareholder would be with the concurrence of the corporation, and therefore, would result in a benefit conferred by the corporation.

If the shareholder and the corporation are dealing at arm's length, any theft or embezzlement of corporate funds or property by the shareholder would normally be without the corporation's agreement. In which case, there would be no benefit conferred by the corporation (this could happen, for example, if the shareholder is a minority shareholder). If a subsection 15(1) benefit does not occur, a theft or embezzlement is generally taxable in accordance with the rules discussed in Income Tax Folio S3-F9-C1, Lottery Winnings, Miscellaneous Receipts, and Income (and Losses) from Crime.

Deductibility of losses - Corporation

The deductibility of losses from the theft or embezzlement of funds by a shareholder is based on the specific circumstances of each case. When subsection 15(1) applies to the shareholder, the corporation cannot deduct the losses.

For more information on the treatment of corporate losses, go to Income Tax Folio S3-F9-C1, Lottery Winnings, Miscellaneous Receipts, and Income (and Losses) from Crime. The shareholder will be taxed even though the corporation may recover part or all of its loss from an insurer. If the corporation is not entitled to deduct the loss, insurance recoveries will not constitute income in its hands.

24.10.8 Sale of property by a shareholder to a corporation

If a shareholder sells property to a corporation at a price that exceeds the FMV of the property, the amount subject to tax under subsection 15(1) of the ITA will be the amount of this excess. The FMV of the property is determined as of the date the transaction takes place.

Income tax implications - Shareholder

Consider these income tax implications:

The benefit conferred on the shareholder under subsection 15(1) may be reduced or cancelled if:

Inclusion of the benefit in the shareholder's income

As a rule, the shareholder will be taxed on a subsection 15(1) benefit from the sale of property by the shareholder to the corporation in the year the sale takes place. This applies even if a liability to the shareholder has been recorded in the accounts of the corporation with only a portion, if any, of the purchase price actually having been paid to the shareholder.

The amount, which will be taxed in that year, will depend upon the security of the debt held by the shareholder. If the debt is completely secured (that is, the corporation has the capacity to pay the debt in full), the benefit will be taxed under subsection 15(1) in the year of sale. Actually receiving the funds at some later date would not result in additional income to report.

If the debt is not completely secured, the amounts subject to tax in the year it was created and in the following years will be the subsection 15(1) amounts paid or secured in the year, as the case may be (that is, there should not be a subsection 15(1) amount outstanding, which is both secured and untaxed).

To make sure that tax is levied only on the benefit or advantage actually conferred on the shareholder as a result of the sale, consider a referral to Business Equity Valuation to determine the FMV of the debt.

Capital gain or loss

If depreciable or non-depreciable property is sold at a price exceeding the shareholder's capital cost or ACB of the property, the amount of the capital gain that would otherwise be recognized on the sale is, according to paragraph 39(1)(a), reduced by the amount of the appropriation determined under subsection 15(1). This adjustment is necessary to eliminate double taxation.

Recapture or terminal loss

The amount of recapture that is added to the shareholder's income under subsection 13(1) on the transfer of depreciable property to a corporation is reduced by the amount of the subsection 15(1) appropriation remaining after first reducing any capital gains realized on the disposition. The reduction to the recapture is in accordance with subsection 248(28), which is intended to prevent double taxation.

Tax implications - Corporation

When a corporation acquires property from a shareholder with whom the corporation was not dealing at arm's length for a price higher than the FMV of the property, consider these income tax implications:

Examples

Example 1

This example shows the amount that will be taxed in a year under subsection 15(1)  when a corporation becomes indebted to the shareholder on the purchase of property from the shareholder and the debt is not completely secured (the corporation does not have the capacity to pay the debt in full).

Facts

AA Ltd. began operations on January 1, 2022. The company's balance sheet at that date was comprised of $1 in cash and capital stock of $1.

The same day, Taylor sold land to A Ltd. for $200,000 in exchange for a $200,000 note. The note was secured by the land, which had a FMV of $150,000 at that time.

The FMV of the note, at this time, with no other assets or liabilities, is equal to the FMV of the land, less the cost to seize the land ($2,000).

Tax implications for the shareholder

A benefit under subsection 15(1) will not be taxed in a year when the FMV of the debt is less than the FMV of the property received from the shareholder.

The benefit is calculated as follows:

FMV of the debt  $148,000 ($150,000 – 2,000)

Less:  FMV of the land  $150,000

Benefit                    Nil

If the financial position of the corporation improves in a later year, the amount subject to tax will be the portion of the subsection 15(1) amount that is secured in the year. For example, if the FMV of the note is $180,000 in year 2, the benefit would be $30,000 (180,000 – 150,000).

Tax implications for the corporation

The cost of the land, according to paragraph 69(1)(a), is deemed to be $150,000, which is its FMV.

Example 2

Sale of property by a shareholder to the corporation.

Facts

Taylor is the sole shareholder of A Ltd. On March 5, 2022, Taylor sold a building (depreciable property) to A Ltd. for $480,000. The capital cost of the building was $285,000, the FMV was $320,000, and the undepreciated capital cost (UCC) was $123,000. Real Estate Appraisal accepted the FMV of the building.

Tax implications for the shareholder
Benefit according to subsection 15(1)
 Proceeds of disposition  $480,000
 Less: FMV    320,000
 Benefit  $160,000
 Capital gain
 Proceeds of disposition  $480,000
 Less: Capital cost    285,000
 Gain  $195,000
 Capital gain prior to adjustment  $195,000
 Less: paragraph 39(1)(a) adjustment (re: subsection 15(1) benefit)    160,000
 Adjusted capital gain  $  35,000
 Taxable capital gain (50% section 38)  $  17,500
 Recaptured amount
 UCC  $123,000
 Less: lesser of the proceeds of disposition and the capital cost    285,000
 Recapture  $162,000

Note: The full amount of the subsection 15(1) benefit ($160,000) was deducted in accordance with paragraph 39(1)a)  to determine the capital gain. Consequently, no amount remains that is being taxed twice which would require the recapture on the disposition to be reduced according to subsection 248(28).

Tax implications for the corporation
 ACB of the building under section 54
 Deemed acquisition cost under paragraph 69(1)(a)   $320,000  
 Adjustment of the building's capital cost according to subparagraph 13(7)(e)(i)
 Taylor's capital cost    $285,000
 Add: ½ of the following difference, if any:    
          Taylor's proceeds of disposition   $480,000  
          Less: Taylor's capital cost     285,000  
    $195,000      97,500
 Revised capital cost for CCA purposes    $382,500

24.10.9 Use of corporation's property

General comments

If corporate property is made available for the personal use of a shareholder, a benefit under subsection 15(1) is considered to have been conferred on the shareholder. This is so, whether or not the shareholder paid a portion of the cost of the property or any related operating expenses. As well, whether the corporation has claimed any CCA on the property is not relevant.

Depending on the circumstances, subsection 15(1) may be applied in conjunction with the provisions of subsection 56(2) if a payment or transfer of property is made to a person, at the discretion or concurrence of the shareholders.

For more information about subsection 56(2), go to:

Determining the value of the benefit

The decision in Youngman v The Queen, 1990 (FCA) 90 DTC 6322, is important for determining the value of a benefit conferred on a shareholder. The court stated:

"In order to assess the value of a benefit…it is first necessary to determine…what the company did for its shareholder; second, it is necessary to find what price the shareholder would have to pay, in similar circumstances, to get the same benefit from a company of which he was not a shareholder".

The calculation of the value of the benefit is usually based on the fair market rent for the property minus any consideration paid to the corporation by the shareholder for use of the property. The fair market rent is most often equal to the rental value of a comparable asset. The fair market rent may not, however, always be appropriate for measuring the benefit, particularly if it does not provide for a reasonable return on the value or cost of the property. This may be the case, for example, for a luxury residence or yacht made available for the shareholder's personal use. In such a case, a rental value will have to be imputed and negotiated with the taxpayer to arrive at a reasonable amount having regard to all the circumstances.

Imputed value of the benefit

The imputed value would be the rent that a potential lessor (the corporation) would demand from an arm's length person to induce the corporation to purchase the particular property for the purpose of renting it to that person. The imputed value is determined by multiplying a normal rate of return (to be determined by Real Estate Appraisal) times the greater of the cost or FMV of the property (you may need to make a referral to Real Estate Appraisal) and adding the operating costs (other than interest paid on liabilities connected with the property) related to the property. The total of these two amounts is often referred to as imputed rent. Any consideration paid to the corporation by the shareholder for the use of the property is subtracted from the imputed rent. When using this formula, the amount representing the greater of the cost or FMV of the property may first be reduced by any outstanding interest-free loans or advances to the corporation made by the shareholder to enable the corporation to acquire the property before multiplying by the normal rate of return.

Other criteria that will be considered by Real Estate Appraisal in determining imputed value include:

A negotiated settlement should not, in most cases, be markedly lower than the imputed value. If an agreement with the shareholder cannot be reached after considering all the facts, the assessment under subsection 15(1) should be issued on an amount equal to the imputed value minus any rent paid.

A negotiated settlement may be less than the imputed value when the property was not acquired mainly for the shareholder's personal use. For example, when a property, initially acquired for business reasons, is subsequently held for the shareholder's personal use, consider any decrease in the FMV of the property a reduction in the imputed value.

The imputed value method is not designed to penalize a shareholder by taxing a premium over the FMV as determined on an arm's length basis. It is an alternate method of determining arm's length fair market rental when comparables are not available.

Benefit calculation period

When a corporation acquires property primarily (more than 50%) for business purposes and the shareholder's use is only incidental, the value of the taxable benefit will be based on the actual use of the property by the shareholder during the year.

On the other hand, when a corporation acquires property primarily (more than 50%) for the shareholder's personal use, the time the shareholder actually uses the property is not relevant in determining the value of the benefit. The value of the taxable benefit is based on the length of time in the year the property was made available to the shareholder, less the time the property was used for business purposes.

To determine if the property was acquired for business purposes, the auditor must review the terms and conditions of the property's use by the shareholder. When the decision to purchase the property was made primarily for the shareholder's personal use rather than for business purposes, it can be assumed that the property was acquired for the shareholder's personal use.

Income tax implications - Corporation

No deduction on account of operating expenses for the property will be allowed to the corporation except, when the rent, if any, paid by the shareholder, if the property was not acquired for the purposes of gaining or producing income.

If the property was acquired for the shareholder's exclusive personal use, it is not considered property acquired for the purpose of gaining or producing income. As a result, under paragraph 1102(1)(c) of the Income Tax Regulations, these types of assets cannot be included in an asset class for the purposes of computing CCA.

The rules in subsections 13(7) and 45(1) of the ITA must be considered in the following circumstances:

24.10.10 Use of specific types of corporate property - Commentary and examples – Under review

Aircraft – Under review

If an aircraft, which is owned or leased primarily for business purposes, makes a flight for business reasons and a shareholder occupies available space on the aircraft for personal reasons, the shareholder derives a taxable benefit. In these cases, the value of the benefit, which must be included in the income of the shareholder, is the equivalent regular commercial economy airfare for a regularly scheduled flight to the same destination. Refer unusual cases to Technical Applications Section, Medium Business Audit Division, Small and Medium Enterprises Directorate in Headquarters.

When an aircraft is maintained by a corporation primarily for the personal use of one or more shareholders, the value of the benefit will be determined based on the facts of each case and the guidelines set out in this subchapter will help in determining the taxable benefit.

Yacht

Example 1

Facts

On January 1, 2021, Holdco bought a yacht for the personal use of its majority shareholder. A weekly fair market rent is not available because it is a deluxe boat. The yacht was available for the shareholder's personal use 353 days in 2021; that is, every day except for the 12 days the yacht was rented to Subco. The $10,000 in rental income was debited to the account payable owing to the shareholder. The yacht's FMV at December 31, 2021, was $270,000.

A reasonable rate of return (cost of equity) for this company at this time (provided by Business Equity Valuation) is 12%.

The financial statements for the period ending December 31, 2011, show:

Financial statements for the period ending December 31, 2011
Balance Sheet    
Assets: Yacht (at cost)  $300,000  
Liabilities:    
Bank loan (to buy the yacht) $100,000  
Shareholder loan (to buy the yacht) $100,000 interest-free
Accounts payable to the shareholder (other than the yacht) $200,000 interest-free
Income Statement    
Rental income from the shareholder $ 10,000 days used = 24
Rental income from Subco 3,000 days used = 12
      Gross rental income $ 13,000  
Operating expenses $  7,000  
Maintenance costs 5,000  
Interest on bank loan 11,000  
Depreciation 10,000  
     Total expenses $ 33,000  
     Net loss from rental of yacht $ 20,000  

Income tax implications - Shareholder

Since the main use of the yacht is personal, the shareholder is subject to a taxable benefit under subsection 15(1). The taxable benefit is calculated on the number of days the yacht was available for the personal use of the shareholder, that is, 353 days in 2021.

The value of the benefit is determined as follows:

Determination value of the benefit
       Note 
Greater of cost or FMV of the yacht  $300,000    
Less: shareholder loan to the corporation  $100,000     
Return on investment (12%) $200,000 $24,000  
 Plus: Operating and maintenance expenses less incidental business use  $12,000 x 353/365 days  11,605  1
 Imputed amount    $35,605  
 Less: rent charged to the shareholder    10,000  
 Benefit under subsection 15(1)    $25,605  

Note 1

Interest costs on the bank loan are not added because the normal return includes interest.

Income tax implications - Holdco

If the yacht was not acquired for the purpose of gaining or producing income, the costs associated with the yacht are not deductible. If they are not incurred in the ordinary course of Holdco’s business of providing the yacht for hire or reward, the operating and maintenance expenses are not deductible according to paragraph 18(1)(l) of the ITA. Paragraph 1102(1)(f) of the Regulations does not allow CCA to be taken if paragraph 18(1)(l) applies to disallow the expenses.

For more information on the deduction of expenses incurred for a yacht, go to Income Tax Interpretation Bulletin IT148R3, Recreational Properties and Club Dues. Paragraph 12 is cancelled by Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment.

Income tax implications - Subco

The $3,000 expense in 2021 for the use of the yacht is not deductible under paragraph 18(1)(l).

Example 2

Facts

  1. The Saskatchewan corporation is controlled by a shareholder who is also its president and director.
  2. The corporation owns a jet ski that cost $20,000 plus $1,000 PST and $1,000 GST for a total of $22,000.
  3. A loan, with interest payable at 8% per annum, was used to purchase the jet ski.
  4. The jet ski is for the shareholder's exclusive use and the corporation does not charge rent or for costs.
  5. The corporation deducted $1,760 in interest expense and CCA of $3,150 (Class 7 at 15% x $21,000 (includes PST)).
  6. The corporation annually paid and expensed (except the GST) $500 jet ski insurance and $500 + $25 GST for repairs and maintenance.
  7. ITCs of $1,000 and $25 were claimed by the corporation for the jet ski.
  8. Assume the reasonable rate of return for calculating the interest benefits is 8% per annum.

Income tax implications

Company Deductions Disallowed
Description Amount Reference
 Jet ski CCA $3,150 18(1)(b)
 Jet ski loan interest 1,760 18(1)(b)
 Jet ski insurance 500 18(1)(a)
 Jet ski repairs and maintenance     500 18(1)(a)
 Total $5,910   
Shareholder Taxable Benefits
Description Amount Reference
 Jet ski standby benefit $1,760  15(1)
 Jet ski operating benefit 1,025  15(1)
 Total $2,785   

The company is not allowed to deduct interest expense, depreciation, or operating costs for tax purposes, as they were not incurred for the purpose of earning income.

The shareholder has an availability (or "standby") benefit equal to what the company would have charged an arm's length user. This rental value may be imputed based on a reasonable rate of return on the invested capital of the company. In this case, the amount or value of the benefits would be 8% of $22,000 or $1,760 a year, plus a $1,025 operating cost benefit. Note that the rental benefit is based on the corporation's tax-included (PST and GST) cost of the jet ski, and the operating benefit is based on the tax-included (PST and GST) operating costs (subsection 15(1.3)).

Case law

Building (condominium, residence, other)

When capital real property is for the exclusive use of the shareholder, the courts have generally considered that shareholders must pay a fair market rent based on an entire year (or the period it was "available for use") if a shareholder uses the building for only part of the year.

A benefit related to a property acquired for business purposes, but also used by a shareholder personally, will likely be calculated based on the number of actual days of use. The fair market rent of a comparable property, prorated for the period of use and increased by related expenses, will be used to calculate the benefit.

Example 1 - Value of the benefit based on fair market rent

Facts

  1. Alpha Corporation bought a new residential condominium, both for business purposes and for the personal use of its sole shareholder and his family.
  2. The shareholder, Mr. Beta, and his family use the condominium during his children's summer holidays, from June 1 to August 31. Mr. Beta pays the corporation $200 for each month he uses the condominium.
  3. The operating costs of the condominium are almost $400 a month.
  4. During the rest of the year, the condominium is continuously rented to various parties with whom the corporation deals at arm's length for $900 a month.

Income tax implications - Shareholder

According to subsection 15(1) of the ITA, Mr. Beta would be required to include in his income a benefit equal to the following amount:

Fair market rent                 3 months x $900    $2,700

Less: consideration paid   3 months x $200         600

Taxable benefit                                                     $2,100

Income tax implications for the corporation

The net rental income of $4,500 will be included in the corporation's income and is calculated as:

Gross rental income                             [($900 x 9) + ($200 x 3)]    $8,700

Less: expenses Footnote i                                [($400 x 9) + ($200 x 3)]      4,200

Net rental income before CCA Footnote ii                                                   $4,500

Example 2 - Value of the benefit based on the imputed value

Facts

  1. A Ltd., a registrant, is a steel manufacturer. In 2020, the corporation bought a deluxe condominium for $1,250,000, plus GST, for the exclusive use of its sole shareholder, Logan.
  2. Logan made a $500,000 interest-free loan to the corporation to enable it to buy the condominium.
  3. The FMV of the condominium was $1,340,000 in 2021
  4. The $46,000 in maintenance costs in 2013 were paid by the corporation and reimbursed by Logan at the end of the year.

Income tax implications - Shareholder

The value of the benefit to be included in computing Logan's 2021 income is based on imputed value and is calculated as follows:

Reasonable rate of return (cost of equity) for the calculation of the interest (provided by Business Equity Valuation) multiplied by the greater of:

The cost less the reduction: $1,250,000 - 500,000 = $750,000

The FMV less the reduction: $1,340,000 - 500,000 = $840,000

$840,000 x 9% = $  75,600

Plus: Operating expenses                                                 46,000

Imputed rent                                                                   $121,600

Less: Consideration paid by Logan                                  46,000

Benefit according to subsection 15(1)                        $   75,600

Income tax implications - Corporation

The corporation is not eligible to claim any expenses for the condominium according to paragraph 18(1)(a) of the ITA. CCA is not allowed according to paragraph 1102(1)(c) of the Regulations.

Case law

Automobile

When a corporation makes an automobile available to a shareholder or to a person related to a shareholder, the shareholder must include in income the value of the benefit derived from the automobile. Under subsection 15(5) of the ITA, the calculation of the taxable benefit is the same as the calculation when an automobile is made available to an employee. For more information, go to 27.10.0.

24.10.11 Additions or improvements to shareholder's property

Shareholder's property leased to the corporation

Income tax implications

Income Tax Interpretation Bulletin IT432R2, Benefits Conferred on Shareholders, paragraph 10, describes the tax effect of additions and/or improvements to a building owned by a shareholder and rented to the corporation. The same guidelines would apply to other property leased to the corporation.

When the amount subject to tax depends upon the increase in FMV of the property related to the additions or improvements, refer the valuation of this increase to Real Estate Appraisal before an assessment is issued.

Benefits determined by means of a valuation may be further affected by the use of the CRA's reimbursement policy. The shareholder will be allowed to correct the situation in any way consistent with our policies, including the transfer of the property to the corporation. If the shareholder reimburses the corporation, there will be an increase in that person's capital cost of the property by the amount of the reimbursement and a corresponding decrease in the cost of the leasehold improvement to the corporation.

If the corporation carries on a construction business, and the corporation constructed additions or improvements, subsection 69(4) of the ITA will apply to the corporation and the FMV of the addition or improvement will be a determining factor for the benefit to the shareholder.

If an addition or improvement vests in the owner of the building, a benefit is considered to have been conferred on the shareholder by the corporation. The amount of the benefit is considered to be the present value of the amount, if any, by which the addition or improvement increases the value of the building to the shareholder at the time the building reverts to the shareholder. This includes factors such as:

If the terms of the lease are later changed in favour of the shareholder or if the lease is annulled before its term expires, a benefit would be created at that time equal to the increase in the shareholder's reversionary interest created by the alteration or cancellation of the lease.

Additions or improvements may not vest in the lessor as, for example, in the case under an emphyteutic lease. As well, it is possible, in some provinces, for the land and building to be owned by different persons. If there may be doubt as to whether a benefit has been conferred, refer the matter to Technical Applications Section, Medium Business Audit Division, Small and Medium Enterprises Directorate, Compliance Programs Branch.

The corporation may obtain a deduction under paragraph 1100(1)(b) or subsection 1102(5) of the Regulations for the improvements made to the property it leases from the shareholder despite the shareholder being subject to tax on the improvements under subsection 15(1) of the ITA. For more information on the possible deduction, go to Income Tax Interpretation Bulletin IT464R, Capital cost allowance - Leasehold interests.

Shareholder's property not leased to the corporation

If a corporation makes improvements to a shareholder's property, which it is not renting, the shareholder will be taxed under subsection 15(1) of the ITA on the actual cost of the addition or improvement.

The amount subject to income tax in a particular year will be that portion of the addition or improvement completed during the year.

If the nature of the business ordinarily carried on by the corporation includes construction, and the corporation made the additions or improvements, subsection 69(4) of the ITA will apply to the corporation and the FMV of the addition or improvement will be a determining factor for the benefit to the shareholder. If the FMV is much less than cost, deal with the particular circumstances on an individual basis.

The corporation cannot deduct the cost of the additions or improvements since they were not made to gain or produce income.

24.10.12 References

Income Tax Folios

Income Tax Interpretation Bulletins

Advance Tax Ruling

Income Tax Rulings

Tax & Charities Appeals Directorate (TCAD) Decision Details

Jurisprudence

Other

A significant portion of the commentary in this subchapter was taken from Taxation Operations Manual (TOM) 13(15)0, Appropriation of Property to Shareholder. TOM 13(15)0 has been taken out of circulation.

24.11.0 Indirect payments and benefits

24.11.1 Introduction

This subchapter discusses subsections 56(2) and 246(1) of the ITA.

If a benefit has been conferred, but not to a direct shareholder, subsection 15(1) won’t apply, but the provisions of subsection 56(2) or subsection 246(1) may apply, if the benefit was made at the shareholder’s direction or with the shareholder’s concurrence or acquiescence. The purpose of these sections is to prevent tax avoidance, which might result when amounts which would be considered income when received by a particular taxpayer, are paid to another person.

Subsection 56(2) applies to arm’s length and non-arm’s length transactions.

Read this subchapter together with Income Tax Interpretation Bulletin IT335R2, Indirect Payments. Also go to:

•        24.10.0, Benefits conferred on shareholders; and

•        Learning product TD1018-000, Transactions between a Corporation and its Shareholders.

24.11.2 For future use

24.11.3 Income tax implications

Subsection 56(2)  of the ITA

Subsection 56(2) is intended to cover cases if a taxpayer seeks to avoid receiving what would otherwise be income in the taxpayer’s hands, by arranging to have the payment or transfer of property made to some other person, either for the taxpayer’s own benefit or for the benefit of another person.

As indicated in Income Tax Interpretation Bulletin IT335R2, Indirect Payments, subsection 56(2) will cause an amount not received by a taxpayer to be added to the taxpayer’s income if these conditions are met:

Subsection 56(2), provides for an exemption from its application for any portion of a retirement pension that is assigned from one spouse or common-law partner to another according to section 65.1 of the Canada Pension Plan or a comparable provision of a provincial pension plan , as defined in section 3 of that Act or of a prescribed provincial pension plan.

To reassess under subsection 56(2), there must be a payment or transfer of property. "Property " is defined in subsection 248(1) to mean, "property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes a right of any kind whatever, a share or a chose in action,… ". According to the Tax & Charities Appeals Directorate (TCAD) Decision Details ITC-97-035 (January 22, 1998), if the use of corporate property is made available by a shareholder to some other person who is not a shareholder of the corporation, and no enforceable right to use the property such as a lease, sale, or gift has been transferred, the CRA cannot apply 56(2). Legal services of the Department of Justice and the Income Tax Rulings Directorate support this decision.

The wording of subsection 15(1) “benefit conferred on a shareholder” and part of subsection 56(2) “for the benefit of the taxpayer” are similar. At times, when a third party is involved, it may not be clear whether the benefit was direct or indirect and CRA may use both subsections together. If a corporation, for no equal consideration, makes a payment on a debt of a shareholder to a third party, the payment is taxed in the shareholder’s hands according to subsections 56(2) and 15(1), provided the payment was not charged to salary or to the shareholder’s loan account.

If the corporation incurs a liability to a third party for goods or services supplied by the third party to a shareholder, the time the liability was incurred, rather than the date of the payment in respect of that liability, is when the benefit was conferred on the shareholder.

Example 1

Facts

Cameron is the sole shareholder of a corporation that owns a farm property. The farm property is no longer used in the corporation’s business.

Cameron allows their child, Avery, and Avery’s family to occupy the farm property and farm part of the land. Avery does not pay rent for the use of the property, but Avery pays the property taxes and is responsible for the general upkeep and maintenance of the property.

Implications

For subsection 56(2) to apply, a payment or transfer of property made at the direction of, or with the concurrence of the corporation or Cameron, to Avery, as a benefit either that the corporation or Cameron desired to have conferred on Avery, must have occurred. In the example, the corporation did not make a payment or a transfer of property to Avery. Unless the corporation grants an enforceable legal right to use the property (for example, a lease), the CRA cannot substantiate for reassessment purposes, that a transfer of property occurred. The fact that the child, Avery, was allowed to use the property does not, in itself, mean that the child acquired the right to occupy the property.

Example 2

Facts

During the 2019, 2020, and 2021 tax years the taxpayer, Drew, was the sole shareholder of B Inc. During those years, B Inc., at Drew’s direction, paid out various sums to their friend, Jamie. The amounts in question totalled $80,000. These amounts were not set up as loans.

Tax implications

The $80,000 is included in Drew’s income for the years 2019 to 2021 according to subsections 15(1) and 56(2).

Subsection 56(2) applies for each particular tax year for these reasons:

•     A payment was made to Jamie.

•     The payment was made pursuant to the direction of the taxpayer.

•     The payment was made as a benefit that the taxpayer desired to have conferred on Jamie.

•     The amount of the payment would have been included in the taxpayer's income had the payment been made directly to the taxpayer (that is, as a subsection 15(1) benefit).

These facts are based on the court decision in Cohen v the Queen, 1996 (TCC) 96 DTC 1454, where Jamie stated that the money was used both for their sole benefit as well as for the benefit of Drew and Jamie as a couple.

Dividends

As stated in paragraph 9, Income Tax Interpretation Bulletin IT335R2, Indirect Payments, subsection 56(2) does not generally apply to dividend income since, until a dividend is declared, the profits belong to the corporation as retained earnings. However, subsection 56(2) may be applicable if dividends are paid to shareholders of a corporation who, having regard to the dividend entitlements of their shares as set out in the articles of incorporation, receive dividends to which they are not entitled and/or if another taxpayer has a pre-existing entitlement to the dividend income paid to shareholders of a corporation.

The above paragraph reflects the decisions of the Supreme Court of Canada in Neuman v MNR, (1998) 98 DTC 6297, and in The Queen v McClurg, (1991) 91 DTC 5001.

Tax avoidance provision - Subsection 246(1) 

Subsection 246(1) of the ITA, provides that if a person confers a benefit on a taxpayer, directly or indirectly, the amount of the benefit is included in the taxpayer's income. Subsection 246(1), however, does not apply unless the amount would have been included in the taxpayer's income if it were a payment made directly to the taxpayer. A benefit is included in the taxpayer's income or deemed to be a payment made for purposes of Part XIII when these conditions are met:

If these conditions are met, the benefit is included in the taxpayer's income or taxable income earned in Canada under Part I in the tax year in which the benefit is conferred. If the taxpayer is a non-resident, the amount of the benefit shall be deemed, for purposes of Part XIII, to be a payment made to the taxpayer for property, services, or otherwise, depending on the nature of the benefit.

Subsections 246(1) and 56(2) are directing provisions; the first applies to the recipient of the benefit and the last to the person conferring the benefit.

If subsection 56(2) does not apply, read the rules in subsection 15(1) together with the anti-avoidance provisions of subsections 246(1) and (2), insofar as they relate to indirect payments or transfers made by a corporation for the benefit of a shareholder or as a benefit that the shareholder desired to have conferred on some other person.

Note, however, that subsection 246(1) will not apply if subsection 246(2) applies. Subsection 246(2) states that if persons dealing at arm's length enter into a bona fide transaction and the transaction is not according to, or part of, any other transaction, and is not to effect payment, in whole or in part, of an existing or future obligation, a benefit will not be regarded as having been conferred by either party to the transaction.

Example

Facts

Spud Ltd. is a wholly-owned subsidiary of Potato Corp. The sole shareholder of Potato Corp. is Noah. In 2021, Spud Ltd. bought a cottage for $480,000. Noah and his family use the cottage during the summer months and occasionally during the winter months for free. A cottage in this area normally rents for $4,300 a month.

Effect of subsection 246(1)

Subsection 15(1) does not apply to the conferral of benefits to the indirect shareholder. Consequently, depending on the circumstances, supplement subsection 15(1) and read together with either the provisions in subsection 56(2) or subsection 246(1). However, subsection 56(2) cannot apply to the calculation of shareholder benefits, as the “use of property” made available by the shareholder (Potato Corp.) to some other person, who is not a shareholder of the corporation (Noah), is not considered to be a "payment or transfer of property" unless there is a lease, sale, or gift that has been transferred.

As a result, subsection 246(1) would apply to include a benefit, according to subsection 15(1), in Noah’s income. If Noah had received the benefit directly, subsection 15(1) would have applied to include the amount of the benefit in Noah’s income.

24.11.4 References

Court cases relating to subsection 56(2)

Benefit amount

Attribution of the proceeds of distribution

Benefit conferred on a trustee

Commissions paid to related corporations

Desire to confer a benefit

Dividends paid to shareholders

Dividends paid to spouses or common-law partners

Transfer of commissions

Transfer of a call option

Transfer of salary

Subrogation of debtor

Contributions paid by third parties

Payments to a management company

Estate settlement

Business income converted to a capital gain

Diversion of funds among companies

Training product

Income Tax Folio

Income Tax Interpretation Bulletins

24.12.0 Shareholder debt

24.12.1 Introduction

This subchapter deals with the tax treatment of shareholder loans and indebtedness.

In 1949, the Supreme Court of Canada, in T. E. McCool  49 DTC 700, held that a loan and indebtedness were not the same. The court stated that a loan required the existence of a lender/borrower relationship, while indebtedness, the existence of a creditor/debtor relationship.

The court quoted Black's Law Dictionary in defining a loan as "Delivery by one party to and receipt by another party of a sum of money upon agreement, express or implied, to repay it with or without interest." (Note: The term loan is not restricted to a loan of money. The CRA recognizes loans of property such as gold and stock.)

The court clarified that indebtedness was simply a sum of money owing from one person to another and that a debt could arise under a contract without the existence of a loan. For example, if a purchaser of property does not pay the purchase price. Examples of indebtedness include the unpaid purchase price of property, unpaid rent and, interest (whether or not it is for a loan), and trade accounts receivable.

24.12.2 Subsection 15(2)  - Shareholder debt

This section is an overview of subsection 15(2). For details, go to Income Tax Interpretation Bulletin IT119R4, Debts of Shareholders and Certain Persons Connected with Shareholders. The bulletin discusses the tax implications to a person or partnership who is a shareholder of a corporation, connected with a shareholder of a corporation, or who owns shares of the corporation through a partnership or trust, regarding a loan or indebtedness from that corporation, a related corporation or a partnership of which that corporation or a related corporation is a member.

Subsection 15(2) of the ITA generally requires a shareholder to include in income, the amount of any loan received or indebtedness incurred from a corporation in a tax year, unless the loan or indebtedness (or part thereof) is specifically excluded. Subsection 15(2) prevents dividends from being paid out in the guise of loans or other indebtedness.

Subsection 15(2) does not apply to corporations resident in Canada or to partnerships, each member of which is a corporation resident in Canada. The borrower may be a non-resident corporation.

Once the auditor has determined that a transaction meets the conditions in subsection 15(2), the auditor must make sure that the loan is not excluded by any one of the exceptions set out in subsections 15(2.2) to (2.6) .

Subsection 15(2) does not apply:

  1. Subsection 15(2.2) - non-resident persons - if the indebtedness is between nonresident persons.
  2. Subsection 15(2.3) - ordinary lending business - if the loan is made to borrowers (whether or not they are employees), if the loan is made in the ordinary course of the lender's business, and bona fide arrangements were made at the time the loan was made for repayment within a reasonable time.
  3. Subsection 15(2.4) - certain employees - if the borrowers are also employees of the lender and only if a specific loan was made for a qualified purpose described in paragraphs 15(2.4)(b) to (d). These loans are excluded if the shareholder is also an employee:
        • A loan made to an individual who is an employee of the lender but not a specified employee of the lender. A                 specified employee is an employee who does not deal at arm's length with the lender or who owns directly or             indirectly at least 10% of the shares of a given class of capital stock of the corporation or of a corporation related         to it.
        • A loan made to an individual who is an employee of the lender or is the spouse or common-law partner of an               employee of the lender to acquire a dwelling or a share of the capital stock of a cooperative housing corporation         acquired for the purposes of inhabiting one of the units.
        • A loan made to an employee to acquire previously unissued fully paid shares of that corporation or a corporation       related to it.
        • A loan made to an employee to acquire a motor vehicle to be used in the performance of the employee's job.
    The exceptions in subsection 15(2.4) are subject to the requirements that the employee or the employee's spouse or common-law partner received the loan because of the employee's employment and not because of any person's shareholdings and at the time the loan was made, bona fide arrangements were made for repayment of the loan within a reasonable time.
  4. Subsection 15(2.5) - certain trusts - to a loan regarding a trust if the conditions described in subsection 15(2.5)  are met. The conditions involve facilitating the purchase and sale of shares of this or a related corporation, by or from employees.
  5. Subsection 15(2.6) - repayment within one year - to a loan that is repaid within one year from the end of the tax year of the lender in which the loan was made and if the repayment is not part of a series of loans or other transactions and repayments.

A taxpayer may be subject to a taxable interest benefit calculated under section 80.4 for any loan or part thereof that has not been included in income under subsection 15(2), as long as an amount remains outstanding.

As stated in paragraph 38 of Income Tax Interpretation Bulletin IT119R4, Debts of Shareholders and Certain Persons Connected with Shareholders, if the borrower is a non-resident, paragraph 214(3)(a) deems, for purposes of Part XIII, amounts which would be included in income under subsection 15(2), if Part I were applicable, to have been paid to the nonresident as a dividend from a corporation resident in Canada. A dividend paid by a corporation resident in Canada to a nonresident is subject to income tax under subsection 212(2) and the lender must withhold and remit the tax to the Receiver General.

Bona fide repayment arrangements

The CRA's main concern for shareholder loans is that bona fide arrangements were made, at the time of the loan, for repayment of the loan within a reasonable time. Whether the period allowed for repayment is "within a reasonable time" is a question of fact. In a given situation, one of the factors the CRA will consider is what would happen in a normal commercial practice. For instance, if an employeeshareholder of a financial institution receives the use of a lowinterest or interest-free credit card, the CRA will look to what is commercially acceptable for the particular debt in determining whether the repayment arrangements are bona fide.

It would be reasonable to conclude that an interest-free loan is not a bona fide arrangement in accordance with normal commercial practices. However, since section 80.4  specifically provides for the calculation of an interest benefit, the CRA has taken the view that an interestfree loan does not actually mean that a bona fide arrangement was not made.

A demand loan is not considered a bona fide arrangement for repayment. A demand loan is open-ended and does not specify when the debtor must make the payment.

The giving of a promissory note by a borrower or the assumption of the loan by another person does not constitute repayment of a loan received by that borrower.

A loan need not be repaid in cash. A payment of property is acceptable. Whenever a payment is made with property other than cash, the amount of the payment will be equal to the property's FMV at the time of the transfer to the lender.

Dividends, bonuses, and salaries may be credited to a shareholder loan account and constitute payment to the extent that such amounts reduce the loan balance outstanding. A payment of employment income in this way is considered to be received (the doctrine of constructive receipt) and is included in the borrower's income in the tax year in which the amount is credited. Withholdings may also be required.

These court cases deal with various aspects of bona fide repayment arrangements:

List of Decisions/Issues and Court Cases
 Decision/Issue  Court Case
 A simple corporate resolution, by itself, to establish appropriate repayment obligations was not considered bona fide.  Deckelbaum v MNR, 1982 (TRB) 82 DTC 1636
 An oral agreement to repay within three to four years was not considered bona fide.  Hendriks v MNR, 1981 (TRB) 81 DTC 939
 The absence of written evidence was considered fatal.  Wright v MNR, 1986 (TCC) 86 DTC 1415
 Repayment arrangements must be made when the loan was made or the indebtedness arose.  Reekie v MNR, 1980 (TRB) 80 DTC 1447
 A demand loan is not considered a bona fide repayment arrangement.  Lavoie v The Queen, 1995 (TCC) 95 DTC 673
 Source of funds  Kalousdian v The Queen, 1994 (TCC) 94 DTC 1722
 Is a promise to repay sometime within a fiveyear period acceptable?  Davidson v The Queen, 1999 (TCC) 99 DTC 933
 Does a failure to repay a loan mean that it no longer complies with the bona fide arrangements requirement?  Hnatuk et al. v The Queen, 1997 (TCC) 97 DTC 674
 Is a promissory note given for a housing loan acceptable if there are no predetermined repayments?  Dionne Jr. et al. v The Queen, 1998 (TCC) 98 DTC 1245
 Are there arrangements for repayment within a reasonable period if a housing loan made to a shareholder/employee is only payable on termination of employment?  The Queen v Silden, 1993 (FCA) 93 DTC 5362

Series of loans or other transactions and repayments

As mentioned earlier, subsection 15(2.6) provides that if the loan is repaid within one year from the end of the tax year of the lender in which the loan was made, and if the repayment is not part of a series of loans or other transactions and repayments, the loan is not included in the income of the borrower under subsection 15(2).

A series is generally restricted to a repayment shortly before the end of the year and the same amount or substantially the same amount is borrowed shortly after the end of the year. Such a repayment is of a temporary nature and is not considered to decrease the loan balance in applying subsection 15(2).

Running loan accounts are not automatically considered a series and all of the relevant factors need to be considered to determine whether a series of loans or other transactions and repayments exists. Bona fide repayments of shareholder loans that result from the payment of dividends, bonuses, or salaries are not considered part of a series of loans or other transactions and repayments. Repayments are generally applied to the oldest outstanding loan or debt first (first in, first out (FIFO) basis) and not according to the last in, first out (LIFO) principle.

These are important court decisions dealing with bona fide repayments of shareholder loan accounts that are not part of a series of loans and repayments:

For more information, go to paragraphs 27, 28, and 29 of Income Tax Interpretation Bulletin IT119R4, Debts of Shareholders and Certain Persons Connected with Shareholders. 

Dealing with what constitutes a series of loan and repayments, go to Tax and Charities Appeals Directorate (TCAD) Decision Details:

24.12.3 Repayment of loan by shareholder

Paragraph 20(1)(j) permits a deduction on the repayment of any loan or indebtedness by the shareholder which was previously included in income under subsection 15(2). The deduction is allowed for the tax year a repayment is made if it is not part of a series of loans or other transactions and repayments.

Before December 22, 1992, a non-resident taxpayer repaying a loan previously deemed to be a dividend under paragraph 214(3)(a) was not allowed a paragraph 20(1)(j) deduction because the loan was not included in income under subsection 15(2). Subsection 227(6.1), provides for a refund of the Part XIII tax paid on a loan deemed to be a dividend if the person, on whose behalf the tax was paid, repays the loan after December 21, 1992. For more information, go to Income Tax Interpretation Bulletin IT119R4, Debts of Shareholders and Certain Persons Connected with Shareholders, paragraph 39.

As indicated in Income Tax Interpretation Bulletin IT119R4 (paragraph 33), paragraph 20(1)(j) applies to a partnership if a loan has been included in calculating the income of the partnership in a preceding year and the partnership subsequently repays the loan.

24.12.4 Subsection 15(2) - Audit issues

Subsection 15(2) will not apply, unless it is clear that there is a loan. While a written agreement is the preferable means of establishing that a loan exists, a written agreement is not necessary. However, in its absence, there must be convincing audit evidence that a loan exists. Such audit evidence could include a corporate resolution setting out the loan and the terms of its repayment.

The audit steps required to determine whether a taxpayer is subject to subsection 15(2) may be recorded on these audit working papers:

Reconciliation, Monthly balance computation, and Analysis of credits

The auditor should take the following steps:

This working paper can also be used to record the auditor's analysis of credits to the shareholder's account to determine whether there are any benefits subject to subsection 15(1) or the existence of income such as dividends, interest, employment earnings, or rent.

Because of the one-year repayment period set out in subsection 15(2.6), a loan or debt incurred in the latest tax year may require a historic review of all related transactions.

Indebtedness income analysis (Subsection 15(2) and Paragraph 20(1)(j) )

Remove any incorrect and later correcting entries to the shareholder's loan account.

For example, the shareholder's loan account was in a $1,088,363 debit balance near the end of the fiscal period when it was credited as follows:

                                                    Shareholder's loan                                      $1,200,000

            To record the transfer of an account receivable from a related company.

                                                    Due from related company                       $1,200,000 

            To record the reversal of AJE #9, which was an incorrect posting.

In determining the amount of repayments during the fiscal period ending June 30, 2021, the $1,200,000 credit must be excluded because it was not a repayment, but rather an error. The auditor should:

Any repayment of indebtedness that was included in income under subsection 15(2) is deductible in the year of repayment in accordance with paragraph 20(1)(j).

Interest benefit calculation (Section 80.4)

Calculate an interest benefit on any outstanding indebtedness that has not been subject to subsection 15(2), including any indebtedness that should have been but was not assessed because the applicable tax year was statute-barred. Subsections 80.4(1) and (2) do not apply for any loan or debt, or any part thereof, that was included in computing the income of a person or partnership under Part I.

Calculate the interest benefit using the prescribed rates in Regulation 4301 and the month-end balances in the account. Using month-end balances would not usually result in a material difference from using daily balances, but if there are significant fluctuations in the account balance between month-ends, consider using the daily balances.

For more information about section 80.4, go to 24.12.4.

Example illustrating subsection 15(2) concepts

Facts

An audit of A Ltd., a Canadian-controlled private corporation (CCPC), indicated that some shareholder loans were made in 2018. A Ltd. has a December 31 year-end.

All of the shareholders are resident in Canada and deal at arm's length with A Ltd. None of the shareholders had received loans before 2018. Since A Ltd. was not in the business of lending money, it was very careful, in each case, to make sure that bona fide arrangements were made at the time the loan was made for repayment within a reasonable time.

Taking all of this into consideration, which of the following loans will be included in the borrower's income under subsection 15(2) in 2018?

A.    A loan to Jordan, a vice-president and 20% Class A shareholder. The loan was made to help Jordan buy previously unissued shares of A Ltd. The loan was made on February 14, 2018, and repaid in full exactly one year later. This type of loan is unavailable to any other employees.

B.    A loan was made to B Ltd., a corporation that owns 25% of the Class A shares of A Ltd. The loan was used to reacquire some of its own shares for cancellation and to repay a bank loan.

C.    A loan to Blake, a corporate executive and 15% owner of Class B shares of A Ltd. This loan was made to help Blake buy a home. The loan was made on July 2, 2018, and repaid, in full pursuant to an early repayment clause in the mortgage, on September 29, 2020. Such loans are unavailable to any other employees.

D.    A loan to Kennedy, the treasurer and 8% shareholder of Class A shares of A Ltd. The loan was used to help Kennedy buy a home computer for employment purposes. Five other employees (none of whom are shareholders) are now working at home and have received similar loans. The loan was made to Kennedy on March 12, 2018, and fully repaid by May 19, 2021.

E.     The same as "D" except for these new facts:

            1) Kennedy owns 11% of the Class A shares, and

            2) none of the exceptions listed in subsections 15(2.3) and (2.4) apply.

Comments

A.    The loan is not included in income under subsection 15(2) by virtue of subsection 15(2.6) because it is repaid by the end of the year (that is, by December 31, 2019) of the lender immediately after the year in which the loan was made.

This loan does not meet any of the exceptions in subsections 15(2.2) through (2.5). The minority shareholder rule set out in paragraph 15(2.4)(a) would not apply, since Jordan is a specified employee because they own more than 10% of one class of shares of the corporation. Paragraph 15(2.4)(c) does not apply because the facts show that the employment capacity test in paragraph 15(2.4)(e) cannot be met because the loan is unavailable to other employees.

An imputed interest benefit under subsection 80.4(2) (shareholder capacity) would apply to the period in the year in which the loan remained still outstanding.

B.    The loan would not be included in the income of B Ltd., because subsection 15(2) does not apply to borrowers that are corporate shareholders resident in Canada. Also, subsection 80.4(2) would not apply for the same reason.

C.    The principal amount of the loan outstanding on December 31, 2019, will be included in Blake’s 2018 income under subsection 15(2) because it was received in their capacity as a shareholder. Such a loan would be excluded from Blake’s income under subsection 15(2) by virtue of paragraph 15(2.4)(b) if the loan had been received in an employment capacity. The facts show that it was received by virtue of shareholdings and, therefore, could not meet the condition in paragraph 15(2.4)(e). The repayment in the year 2020 will result in a tax deduction under paragraph 20(1)(j) in that year.

The loan could also have been excluded by subsection 15(2.6) if it had been repaid in full by December 31, 2019. As well, subsection 80.4(2) will apply to impute an interest benefit for any loan principal repaid before January 1, 2020. Such benefit will be calculated for the period such amounts are outstanding.

D.    Kennedy will not have to include any amount for the computer loan in their income under subsection 15(2). Although there is no specific mention of a loan to acquire a computer, paragraph 15(2.4)(a) allows any loan to a shareholder who is not a "specified employee" (defined in subsection 248(1)) to be excluded as long as bona fide arrangements for repayment are made and the loan is received in an employment capacity (paragraphs 15(2.4)(e) and (f). A specified employee is an employee who is either a specified shareholder (that is, generally, a person who holds at least 10% of the shares of any class of the corporation at any time in the year) or a person who does not deal at arm's length with the corporation. Since Kennedy owns less than 10% of the shares of a class and deals at arm's length, they are not a specified employee. Subsection 80.4(1) will however apply to impute an interest benefit for the period of time during which the loan balance is outstanding.

E.     The 11% shareholding in a class of shares means that Kennedy is a "specified employee" as defined in subsection 248(1). This prevents Kennedy from using the minority shareholder exception in paragraph 15(2.4)(a) to exclude the loan from subsection 15(2). As well, the purchase of a computer is not one of the specified purposes in paragraphs 15(2.4)(b) to (d) that would exempt the loan.

Application of subsection 15(2) and paragraph 20(1)(j) when a "series"

As indicated in paragraph 34 Income Tax Interpretation Bulletin IT119R4, Debts of Shareholders and Certain Persons Connected with Shareholders, when there is a series of loans or other transactions and repayments, the exception in subsection 15(2.6) does not apply, unless bona fide repayments are made. Loans which do not meet this test are included in income under subsection 15(2) without allowing the one year for repayment, unless they come within one of the other excepting provisions of subsections 15(2.3) to (2.5).

Refer to the example in paragraph 36 of Income Tax Interpretation Bulletin IT119R4, which illustrates the analyses of a shareholder's loan account to determine the amount to be either included under subsection 15(2) or deducted under paragraph 20(1)(j) in calculating the income of a particular tax year of the borrower.

24.12.5 Section 80.4 - Benefit on interest-free or low-interest loans

This section of the Income Tax Audit Manual discusses the tax of benefits arising from certain interestfree or low-interest loans or debts. Section 80.4 sets out a formula and various other rules for the calculation and inclusion in income of taxable benefits that may be deemed to have been received as a result of receiving loans or incurring debts that bear less than a prescribed rate of interest. Subject to certain exceptions, these deemed benefit provisions are applicable if the loan or debt is received by virtue of an office or employment of an individual, by virtue of the services provided by the personal services business of a corporation, or by virtue of shareholdings in a corporation.

Read this section together with Income Tax Interpretation Bulletin IT421R2, Benefits to individuals, corporations, and shareholders from loans or debt.

Capacity in which a person receives a loan

Subsection 80.4 is divided into two main subsections that present not only different calculations, but also may impose tax liability on different persons, depending upon the circumstances. The capacity in which a person receives a loan will determine the subsection that will apply. Accordingly, subsection 80.4(1) applies when a loan is received in an employment capacity. It applies to individual employees or to an incorporated employee (a corporation carrying on a personal services business).

Subsection 80.4(2) applies when a loan is received in a shareholder capacity. This provision specifically applies to persons or partnerships excluding resident Canadian corporations or partnerships composed solely of such corporations.

Loans received in any other capacity are not subject to section 80.4.

Subsections 80.4(1) and (2) will continue to apply to outstanding loans or indebtedness, even if the employee stops being an employee and the shareholder stops being a shareholder. The test of capacity occurs at the time that the loan is made. A person or partnership is considered to have received a loan or incurred a debt when the funds are advanced or the relevant documents are executed and the person or partnership becomes legally obligated to repay the loan or discharge the debt.

Employee benefit – Subsection 80.4(1)

Subsection 80.4(1) applies when:

Subsection 80.4(1) only states that the loan must relate to employment. In the situations described above, the lender is also the employer of the individual by virtue of whom the loan is made. However, it is important to note that subsection 80.4(1) may apply even if the lender is not the employer.

If an employer helps an employee to obtain a loan, for instance, by providing support for the employee's loan application, the loan will be considered to have been received by virtue of employment. If the employee obtains a loan without the help of the employer, any assistance by the employer to subsidize the interest costs of the employee will not cause the loan to be received by virtue of office or employment. The interest subsidy will however be included in the employee's income under subsection 6(1)(a).

Calculation of the benefit – Subsection 80.4(1)

Paragraph 80.4(1)(a) applies in respect of the balance of all loans outstanding at any time in the tax year of an individual or a corporation which carries on a personal services business in a tax year. A separate calculation is not made under subsection 80.4(1) for each loan; rather the interest benefit is aggregated for all such loans.

The amount under paragraph 80.4(1)(a) is the deemed interest calculated at the prescribed rates in effect for the period during the year in which the loan is outstanding. Interest is calculated for each day the loan is outstanding. It is not necessary that the loan remain unpaid at the end of the year of the borrower for a benefit to be calculated. If the loan is repaid in the year, the benefit is calculated on the number of days that the loan was outstanding in that year.

Paragraph 80.4(1)(b), provides for an addition to the interest benefit amount when interest on the loan is paid or payable for the year by certain third parties on behalf of the borrower. Therefore, such interest will be added to the calculation of the interest benefit if it is paid or payable by any of the following persons:

Paragraph 80.4(1)(c), provides that the benefit calculated for a person or partnership will be reduced by the amount of any interest paid in respect of any such loans in the year or within 30 days thereafter, regardless of the identity of the payer. Accrued interest at year-end is not considered, unless it is paid within the 30-day period.

Paragraph 80.4(1)(d) reduces the benefit calculation if the borrower reimburses, in the year or within 30 days thereafter, any portion of the interest the person or entity described in paragraph 80.4(1)(b) had paid on the loan.

Subsection 80.4(7) defines, for the purposes of section 80.4, the "prescribed rate." The reference to “prescribed” refers to section 4301 of the Regulations.

Shareholder benefit – Subsection 80.4(2)

Subsection 80.4(2) applies when a loan is received by a person or a partnership described in the subsection in the capacity of a shareholder. The benefit under subsection 80.4(2) is deemed to be received by the person or the partnership who received the loan or debt and not by the shareholder by virtue of whom the loan or debt was made.

For example, a loan is made to the spouse or common-law partner of a shareholder and by virtue of that person's shareholdings. The spouse or common-law partner, not the shareholder, will be required to include the imputed interest benefit in income.

Calculation of the benefit – Subsection 80.4(2)

The benefit is calculated as the difference between paragraphs 80.4(2)(d) and (e) for each tax year in which the loan remains outstanding.

Paragraph 80.4(2)(d) applies for all loans of the person or partnership which are outstanding at any time in a tax year. If a person or partnership has received two or more loans that were outstanding in the tax year, the interest benefit will be determined by totalling the interest benefits for all such loans.

The calculation of the paragraph 80.4(2)(d) amount consists of applying the prescribed rates (section 4301 of the Regulations) on a daily basis to the outstanding loan balance.

It is not necessary that a loan balance remain outstanding at the end of the year for a benefit to be calculated. If the loan or debt is repaid in full before the year-end, the benefit is calculated for the number of days in the year during which the loan was outstanding.

Paragraph 80.4(2)(e) applies to reduce the amount of the benefit by the amount of interest paid on all such loans in the year or within 30 days thereafter by any party. Interest payable at yearend does not reduce the interest benefit, unless such amounts are actually paid within 30 days after that year-end.

If a corporation pays the interest on a loan on behalf of one of its shareholders, the amount of interest paid will be considered in the calculation in paragraph 80.4(2)(e).

This could occur if a shareholder received a loan from a related corporation and the corporation in which he or she owns shares pays any part of the interest. In such cases, the payment of interest by the corporation reduces the interest benefit to the shareholder under paragraph 80.4(2)(e). However, a benefit of an equal amount arises under subsection 15(1), since the corporation has provided the shareholder a benefit by paying the debt.

Exceptions set out in subsection 80.4(3)

Subsection 80.4(3) provides exceptions to the rules set out in subsections 80.4(1) and (2). Paragraph 80.4(3)(a) provides that a benefit will not arise if the rate of interest payable on the debt is equal to or greater than the rate of interest that would have been agreed upon in an arm's length transaction at the time the obligation was incurred.

There are two assumptions to consider:

  1. none of the parties received the loan because of an employment or shareholder capacity; and
  2. the ordinary business of the lender included lending money.

However, this exception will not apply if a party other than the debtor pays any interest on the debt to the creditor, even if the interest was negotiated at normal commercial rates.

For example, on August 30, 2020, an individual obtains a $100,000 loan at 8% interest from a corporate employer. Assume that the loan meets the requirements of paragraph 80.4(3)(a). Therefore, no imputed interest benefit will apply under section 80.4. If in 2021 a related corporation agrees to pay one-quarter of the interest (2%), then section 80.4 will apply in that year. A benefit will only be determined, however, if the prescribed rate exceeds 6% (the net amount that the individual is required to pay).

As stated in paragraph 10 of Income Tax Interpretation Bulletin IT421R2, Benefits to individuals, corporations, and shareholders from loans or debt, paragraph 80.4(3)(b), provides that subsections 80.4(1) and (2) do not apply if another provision of Part I of the ITA brings the loan or debt into the income of the debtor. For example, neither subsection 80.4(1) nor (2)apply if subsection 15(2) has already brought the loan or debt into the taxpayer's income. An assessment under subsection 15(2) is not precluded, even if the taxpayer has voluntarily reported a benefit under section 80.4. Subsection 15(2) has priority over section 80.4.

Loans to shareholder-employees

As indicated in Income Tax Interpretation Bulletin IT421R2, Benefits to individuals, corporations, and shareholders from loans or debt, the capacity in which a person or partnership receives a loan is significant because that capacity determines whether any benefit is to be computed under subsection 80.4(1), as a result of an office or employment or under 80.4(2), as a result of shareholdings. If a person is both an employee and a shareholder, it is a question of fact whether a loan arose as a result of the person's shareholdings or as result of the office or employment. For more information about benefits arising by virtue of shareholdings, go to Income Tax Interpretation Bulletin IT421R2  paragraphs 6 and 7.

Once a loan or other indebtedness becomes subject to the provisions of section 80.4, it remains subject to those provisions for all tax years until fully repaid. Therefore, a loan obtained by reason of shareholdings can continue to be subject to section 80.4, even if the recipient of the loan is no longer a shareholder.

Income Tax Interpretation Bulletin IT421R2 , Benefits to individuals, corporations, and shareholders from loans or debt, paragraph 9, states that a benefit, calculated under the provisions of section 80.4, is brought into the income of an individual, partnership, corporation, or shareholder, as the case may be, according to these provisions under:

a) subsection 80.4(1) benefits:

b) subsection 80.4(2) benefits, under subsection 15(9).

Deductibility of interest assessed under section 80.4

Section 80.5, provides that a benefit is included in the income of a taxpayer under section 80.4 for employee or shareholder debt, the amount of the benefit is deemed to be interest paid in the year according to a legal obligation for borrowed money for the purposes of the rules in subparagraph 8(1)(j)(i) and paragraph 20(1)(c). Therefore, if the borrowed funds are used to earn income from business or property, the amount of the interest may be deductible in computing the income of the taxpayer.

Under subparagraph 8(1)(j)(i), employees are permitted to deduct interest on funds borrowed to buy a motor vehicle or aircraft if they are eligible to deduct expenses under either the salesmen's or travel expense provisions, that is paragraphs 8(1)(f), (h), or (h.1). Therefore, if a benefit is included in the income of an employee under section 80.4 and the borrowed funds are used to acquire a motor vehicle or aircraft, the employee is allowed to treat the section 80.4  benefit as interest expense under subparagraph 8(1)(j)(i).

Non-residents

Non-resident tax under subsection 212(2) may apply if a corporation resident in Canada makes a loan to a shareholder, or to any other person or partnership described in subsection 80.4(2). In such cases, any benefit deemed to have been received under subsection 80.4(2) which would be included in the recipient's income for the year under subsection 15(9) if the recipient were resident in Canada, will, by virtue of paragraph 214(3)(a), be subject to non-resident tax under subsection 212(2) for any tax year in which the recipient is a non-resident.

If a non-resident is employed in Canada and received a loan or otherwise incurred a debt by virtue of that employment, any benefit deemed received under subsection 80.4(1) is included in computing the non-resident's taxable income earned in Canada by virtue of subsections 2(3), 6(9), and 115(1).

24.12.6 Subsection 80.4(2) of the ITA - Audit issues

Whether subsection 80.4(1) or 80.4(2) applies

It is important to determine if subsection 80.4(1) or 80.4(2) apply to a loan received by an employee-shareholder because:

The CRA's assessment policy regarding section 80.4, subsection 15(2.6), and paragraph 20(1)(j)

The CRA's November 22, 1994, revised position on assessments gives more importance to section 80.4 than to subsection 15(2.6) and paragraph 20(1)(j). The new policy is:

For more information, go to Tax & Charities Appeals Directorate (TCAD) Decision Details ITC-93-009R, dealing with the CRA's position on what constitutes a series of loans and repayments.

Example

Suppose you audit an individual in May 2014 for the 2012 and 2013 tax years. The individual is a shareholder of a corporation whose fiscal period ends June 30. In May 2012, the taxpayer borrowed $40,000 from the corporation, and, in September 2012, an additional $60,000.

You conclude that none of the exceptions in subsections 15(2.3) or (2.4) apply. The loans were not repaid before the audit, and there is no indication the loans will be repaid in the near future. Under subsection 15(2.6), the individual has until June 30, 2013, to repay the $40,000 loan and until June 30, 2014, to repay the loan of $60,000.

However, our policy says that the interest benefit be calculated under section 80.4  for 2012 without waiting for the oneyear repayment period per subsection 15(2.6) and code the file for a followup audit. If during the follow-up audit, it is determined that the loan is taxable under subsection 15(2), a reassessment will be issued to delete the 80.4 benefit and tax the shareholder under subsection 15(2).

Interrelationship of subsection 15(2) and section 80.4

Paragraph 80.4(3)(b) provides that no benefit will be assessed under section 80.4 for any amount included in income under Part I. For this reason, subsection 15(2) is considered to take precedence over section 80.4. As a result, shareholder loans and indebtedness will be assessed under subsection 15(2) whenever that subsection applies, notwithstanding that section 80.4 would otherwise apply.

If a taxpayer has already reported a section 80.4 benefit when it should have been taxed under subsection 15(2), a reassessment will be issued to delete the section 80.4 benefit and tax the shareholder under subsection 15(2), unless the difference would be minor.

If a repayment of a loan or indebtedness has been made in a year, no carry-back to the previous year will be permitted. Instead, assessments will be issued under subsection 15(2) and paragraph 20(1)(j) in respect of the years in which the loan or indebtedness was incurred and repaid.

Offsets can be allowed in accordance with the policy described in the next section, Offsetting accounts receivable and payable (paragraph five).

A shareholder loan or indebtedness, which is not taxable under subsection 15(2), will, of course, be governed by section 80.4. As well, when the loan or indebtedness, or a major portion, arose in a year which is now statute-barred, section 80.4 will be applied to tax the benefit until such time as it has been repaid.

Offsetting accounts receivable and payable

Income Tax Interpretation Bulletin IT421R2, Benefits to individuals, corporations, and shareholders from loans or debt, paragraph 14, states that, "Generally, no netting or offsetting of any accounts "due to" or "due from" the shareholder or employee will be deemed or considered to have taken place so as to eliminate the calculation of a benefit during a particular period." However, offsets or netting will be allowed in certain circumstances.

The CRA's policy on offsets or netting will apply to assessments issued under subsection 15(2) as well as section 80.4.

Whenever offsets or netting are permitted, the corporation will be required to make all the necessary entries and resolutions in its books and records in order to give proper (and legal) effect to the offsets. This will have to be done before the audit is finalized if the offset is to be approved.

If it appears that an offset or netting will benefit a shareholder, that person must, in all cases, be given the opportunity to request that it be applied.

Offsets can be allowed if the terms of the loans to and from a shareholder are the same. For example, an interestfree loan from the corporation could be offset by a similar loan to the corporation. On the other hand, if the loans have different terms (interest rate, period, or maturity), no offset would be allowed.

If a third-party lender to a corporation requires that a shareholder maintain a credit balance with the corporation, that credit will not be available to the shareholder as an offset.

Offsets will not ordinarily be permitted if an individual has offsetting accounts with two different corporations or if a corporation has accounts with different individuals. However, there could be some situations where, in the auditor's judgement, a refusal to allow such an offset would be clearly unfair. This could arise, for example, if the taxpayer was inexperienced and was completely unaware of the tax implications and there appears to have been no reason for setting up separate accounts in the first place.

Case law generally requires that the intention to offset be clear and unequivocal.

Go to:

To ensure proper and legal effect, make sure that:

Accrued salaries and bonuses

An accrued salary or bonus is taxable in an employee's hands at the time when it is received. This is when a cash payment is made or, if no such payment is made, when the amount is applied against amounts owing by the employee to the employer.

If the employee has included the accrued salary or bonus in income at a particular time, but the amount was not credited to that person's loan account, the employee and the employer will be asked whether payment was made and if so, on what date. The salary or bonus will be considered to have been paid on the day indicated by them for purposes of subsection 15(2) and section 80.4 according to the offset practice as discussed above.

Withholding tax ordinarily must be remitted to the CRA in the month following that in which the payment or offset is made. Limit Audit involvement in connection with withholding requirements on payments effected by offsets to a notification to the Trust Examination Section that such an offset has been made. The extent to which these referrals are pursued is a decision to be made by the Trust Examination Section and not by Audit.

If the employee and employer indicate that payment has not been made, the salary or bonus will not constitute income in the employee's hands at that time, and an adjustment may have to be made to delete it from the reported income. Subsection 78(4) may apply to the employer.

Accrued salaries and bonuses, which are used as offsets, will neither reduce nor eliminate any benefits under section 80.4 arising prior to the effective date of the offsets.

The crediting of a bonus, salary, or a dividend against an existing debt does not, in any way, mean that the debt has been brought into income. Consequently, paragraph 80.4(3)(b) does not apply in this situation.

Calculation of the section 80.4 benefit

The shareholder loan and indebtedness accounts must be analyzed to arrive at the amounts subject to subsection 15(2) and paragraph 20(1)(j).

The amount of the shareholder's loan or indebtedness that is subject to section 80.4 must then be determined for each tax year. This is done by taking the current shareholder loan balance, subtracting all amounts assessable under subsection 15(2) for that year and all previous years, and adding all previous years' paragraph 20(1)(j) deductions.

If the balance at the end of a statute-barred year is assessable under subsection 15(2), calculate two separate benefits under section 80.4 for transactions made:

  1. in the current years, the benefits are determined, as explained in the previous paragraph; and
  2. in statute-barred years, section 80.4 will apply to the full statute barred balance.

Amounts assessed under subsection 15(2) are specific amounts on specific dates and are removed from the calculations for section 80.4 benefits. When a deduction under paragraph 20(1)(j) is claimed for the repayment of a subsection 15(2) amount, it is also calculated on a specific date.

Example

Corp A Ltd. loans its shareholder Harper $100,000 on July 1, 2018, 2019, and 2020. Corp A has a June 30 year‑end. Harper makes their first repayment of $20,000 on September 1, 2021.

Result

Because the first $100,000 was not repaid by the end of June 30, 2020, Harper will be assessed a subsection 15(2) benefit on their 2018 T1 Income Tax and Benefit Return. Since the second $100,000 was not repaid by the end of June 30, 2021, Harper will be assessed a subsection 15(2) benefit on their 2019 return.On Harper’s 2021 T1 return, Harper claims a paragraph 20(1)(j) deduction for $20,000. The amount of the shareholder loan balance on December 31, 2021 is $280,000 (3 * $100,000 - $20,000).

To calculate the amount on which section 80.4 applies in 2021:

•        Amount of the shareholder loan balance: $280,000

•        Less the amount of subsection 15(2) in all years: $100,000 + $100,000

•        Plus any paragraph 20(1)(j) repayments in all years: $20,000

The result is that section 80.4 will apply to $100,000 of the balance. $80,000 will have interest calculated for the entire 365 days, but $20,000 will only have interest calculated from January 1, 2021, until payment was made on September 1,2021.

Because of the one-year repayment period set out in subsection 15(2.6), a follow-up audit may be required if a loan or indebtedness arose in the most recent year filed.

Daily balances should be used to compute benefits according to section 80.4. However, in most cases, the use of a balance, taken in the month as the average for that month, will yield the same results and is allowable. If these monthly balances are not representative or if the taxpayer objects to their use, daily or weekly balances can be used.

Forgiven loans

As indicated in paragraph 11 of Income Tax Interpretation Bulletin IT421R2, Benefits to individuals, corporations, and shareholders from loans or debt, if a loan to an employee is forgiven, the amount forgiven is income in the hands of the employee in accordance with subsection 6(15). However, paragraph 80.4(3)(b) would not apply to reduce any benefit included in the employee's income according to subsection 80.4(1) in a prior year for such a loan.

Similarly, if a loan to a shareholder is forgiven, the forgiven amount is income in the shareholder's hands under subsection 15(1.2) in the year of forgiveness, but this would not reduce a benefit included in income for a previous year under subsection 80.4(2), assuming that subsection 15(2) did not earlier apply to the same loan.

Example 1 - Application of subsection 80.4(2)

The following example illustrates the calculation of a benefit under subsection 80.4(2) in 2021 for an individual who borrows $200,000 from the corporation in the capacity as a shareholder. Suppose that the prescribed interest rate is 5% for the first three quarters of the year and 6% for the last quarter. The loan was made on January 1, 2021, and no repayment has been made. The shareholder paid $3,000 in interest in 2021 and $2,500 on January 10, 2022.

The benefit under subsection 80.4(2) would be:

$200,000 x 5% x 3/4       $7,500

$200,000 x 6% x 1/4    3,000

                                     $10,500

Less: interest paid        $5,500

Taxable benefit for 2021 $  5,000

Example 2 - Application of subsections 80.4(1) and 80.4(2)

Facts

On May 15, 2021, Madison obtained a $200,000 loan from a financial institution to buy astronomy equipment with the assistance of their employer, Z Inc. Madison wasn't able to obtain the loan without the help of their employer. The terms of the loan were:

•     Madison had to make interest payments of $300 per month beginning June 30, 2021. Of this amount, $200 had to be paid directly to the financial institution and $100 had to be paid to the employer through payroll deductions. Madison was paid their salary on the 30th of each month. An annual principal repayment of $10,000 was due on November 15.

•     Z Inc. paid the financial institution monthly interest payments of $600, starting on June 30, 2021.

Application of subsection 80.4(1)

Under subsection 80.4(1), Madison is deemed to have received a benefit equal to the amount, if any, by which the total of:

a) the interest at the prescribed rate:

$200,000 x 5% x 45/365 days                   $1,233

$200,000 x 5% x 92/365 days                     2,521

$200,000 x 6% x 45/365 days*                   1,479

$190,000 x 6% x 47/365 days                     1,468

                                                    $6,701

Plus

b) the interest paid or payable in the year by:

(i) Z Inc. ($600 X 7 months)                       $4,200

(ii) and (iii) N/A                                                     0         4,200

                                                         $10,901

Exceeds:

c) the interest paid on the loan by:

the employee ($200 x 7 months)            $1,400

the employer ($600 x 7 months)               4,200       $5,600

d) any portion of the amount in (b)

paid by the debtor ($100 x 7 months)                            700

                                            $6,300

Benefit under subsection 80.4(1)                                $4,601

*The CRA calculates the period as including the first day, but excluding the date of the repayment. This approach follows normal business practice.

According to subsection 6(9), Madison must include $4,601 in their income for the 2021 tax year as income from an office or employment.

Note that the interest the employer paid the bank is taken into consideration twice when calculating the benefit. An amount of $4,200 was added to the calculation according to paragraph 80.4(1)(b), and the same amount was deducted under paragraph 80.4(1)(c). Therefore, the fact that the employer paid interest on the employee's behalf did not increase the benefit deemed received by the employee. The only time this situation will affect the calculation of the benefit, is when the interest paid or payable by the employer (80.4(1)(b)) exceeds the interest actually paid by the employer (80.4(1)(c)).

In summary, the deemed benefit ($4,601) equals the interest at the prescribed rate ($6,701) less the interest Madison paid directly to the bank ($1,400) and the interest Madison reimbursed to Z Inc. ($700).

The net interest paid by Z Inc. to the financial institution is a deductible business expense, to the extent that such interest, together with all other remuneration to Madison, is reasonable in relation to the value of the services Madison renders to their employer.

Note: This differs markedly from a loan received in a shareholder capacity. The difference is attributable to the fact that employee-related expenses are considered laid out for the purposes of earning income; whereas expenses related to shareholders do not.

Application of subsection 80.4(2)

If Madison is also a Z Inc. shareholder and received the loan in this capacity, the benefit would be calculated in the following way:

(a) The amount by which interest at the
      prescribed rate                                                               $6,701

Exceeds:

(b) The interest paid on the loan in the
      year by:

      Z Inc. ($600 x 7 months)                                $4,200

      Madison to the bank ($200 x 7 months)            1,400       5,600

Subsection 80.4(2)  deemed benefit                                 $1,101

(Benefit to the shareholder according to

subsection 15(9) and included in income

under subsection 15(1))

Benefit under subsection 15(1)

Personal expenses paid by the corporation   $4,200

Less: amount repaid by Madison                             700     3,500

Total benefit                                                                        $4,601

Even though the total benefit is the same whether Madison receives the loan in their capacity as an employee or shareholder, the amount of the benefit deemed to be interest paid under section 80.5 differs. If the loan was received in Madison's capacity as a shareholder, the deemed interest paid is $1,101. In Madison’s capacity as an employee, it is $4,601.

24.12.7 References

Income Tax Interpretation Bulletins

Court cases

Loan and indebtedness

Subsection 15(2)  of the ITA– Canadian Charter of Rights and Freedoms

Whether an estate was connected to the shareholders of a corporation

Demand loans

Loan received as borrower or shareholder

Loan documentation

Training product

Income Tax Rulings

Some of the comments in 24.12.4 were taken from TOM 13(15) 2.1 to 2.4. TOM 13 has been withdrawn from circulation.

24.13.0 Transfer of property to a corporation by shareholders

Introduction

A person who wants to incorporate their business, would normally trigger tax consequences when they disposed of their assets at FMV to the new corporation. However, the ITA allows a transfer of eligible property for an elected amount if the shareholder or a member of a partnership transfers the property to a "taxable Canadian corporation" or to a "Canadian partnership." This amount may be different from the FMV under certain conditions, thereby allowing the deferral of the tax implications that otherwise would occur upon disposition.

This section deals primarily with the CRA’s position if a property is transferred under section 85 of the ITA. Generally, however, the CRA policy for rollovers may also apply to:

24.13.1 For future use

24.13.2 Transfer of property - Income tax implications

Legislation

Section 85 of the ITA allows, under specified circumstances, a property rollover without causing taxable income for the transferor. To make use of this section, the transferor and the corporation (transferee) must fill in and file Form T2057, Election on disposition of property by a taxpayer to a taxable Canadian corporation. It must be filed at the earliest due date of the income tax returns for either of the two parties involved. The filing requirements and the late or amended filing of an election are set out in subsections 85(6) to 85(9).

The transferor may be an individual, a corporation, or a trust and either a resident or non resident. A partnership may also be the transferor according to subsection 85(2), using Form T2058, Election on Disposition of Property by a Partnership to a Taxable Canadian Corporation.

When a non-resident makes a transfer of property under subsection 85(1) of the ITA, consult the TSO International Audit Section to ensure the provisions of the ITA (for example, section 116 of the ITA - Clearance Certificate) and Income Tax Convention are considered.

The transferor’s property must be transferred to a "taxable Canadian corporation." Subsection 97(2) provides for a comparable rollover to a "Canadian partnership."

Property eligible for rollover

Only "eligible property" defined in subsection 85(1.1) of the ITA may be transferred according to subsection 85(1). Briefly, these properties are not eligible to be transferred:

For more information on "eligible property," go to paragraph 4 of Income Tax Interpretation Bulletin IT291R3, Transfer of Property to a Corporation Under Subsection 85(1). 

Note: The inclusion of ineligible property in an election does not make the election for other eligible property invalid. A property omitted is considered a property having been subject to a FMV disposition.

Agreed amount respects various limits

The amount (proceeds of disposition) the transferor and transferee agree to, is the basis for computing several of the income tax implications of a rollover. Although the taxpayers may choose the agreed amount, subsection 85(1) sets out the range in which the agreed amount must absolutely fall, as follows:

Minimum limit is the greater of (a) and (b) below:

(a) For all property = FMV of non-share consideration (paragraph 85(1)(b))

               (b) Minimum limit - Different types of properties

Inventory   
(b) Lesser of:

Non-depreciable capital property
(b) Lesser of:

Depreciable capital property
(b) Least of:

Eligible capital property
(b) Least of:

Order of property disposition

When more than one depreciable property or more than one eligible capital property are transferred simultaneously to a corporation, each property is transferred as if they were done separately in the order designated by the taxpayer according to paragraph 85(1)(e.1) of the ITA.

The transfer of the first depreciable property would reduce the balance of the UCC in its asset class. When the next property is transferred, the UCC balance will reflect the transfer of the previous property.

In general, if the non-share consideration received is not greater than the UCC of the asset class, there is a disposition order that would allow a recapture to be avoided. However, if the nonshare consideration can be linked to a specific property, a recapture is possible.

Note: Depreciable properties are generally entered on the prescribed form by order of class. The auditor must ask for the disposition order when the amounts of the transactions indicate that a review is required. Audit findings that require further analysis include:

Cost of the consideration received

The agreed amount is used to determine the transferor’s cost of all the properties received in consideration.

The cost of the consideration can be determined as follows:

Nature of the shares received in consideration for the property

Paragraph 85(1)(i) of the ITA deems the shares received to be taxable Canadian property when the property transferred was a taxable Canadian property for the transferor. Therefore, a nonresident could be subject to tax in Canada on any gain realized on the sale of shares received as consideration.

Section 54.2 of the ITA deems the shares received to be capital property when 90% or more of the assets used in an active business were transferred to a corporation. Therefore, any subsequent disposition of shares will be treated as a taxable capital gain rather than as business income. A taxpayer who is an individual could be eligible for the capital gains deduction according to section 110.6.

Paid-up capital adjustment

Subsection 85(2.1) of the ITA is an anti-avoidance provision that allows the paid-up capital (PUC) of the shares received, in consideration for a transferred property, to be adjusted. Paragraphs 85(2.1)(a) and (b) are sometimes referred to as the “PUC grind” and “PUC bump,” respectively. These paragraphs make sure that any increase in PUC in excess of the cost (usually the agreed amount) minus the FMV of the nonshare consideration is removed when considering certain later transactions. Without the “grind,” when the shares were redeemed it was possible to avoid deemed dividends under subsection 84(3) and instead experience gains which could have preferential tax treatment. The “bump” generally makes sure that the shares left in the class are not affected.

When the auditor applies subsection 85(2.1), both the transferor and transferee listed on Form T2057, Election on disposition of property by a taxpayer to a taxable Canadian corporation, or Form T2058, Election on Disposition of Property by a Partnership to a Taxable Canadian Corporation, must be informed in writing and a copy of the letter must be added to the permanent document folder of both parties.

A reduction of PUC does not have immediate income tax implications. However, implications occur when the PUC is used, such as at the time of the share repurchase or when the PUC is returned to the shareholder. This is a permanent adjustment to a class of shares. When shares are redeemed, the taxpayer must include the reduction of PUC in computing the deemed dividend according to subsection 84(3). As PUC is calculated at any time, it does not matter if the year of the rollover is statute-barred. As well, as the shares may have been sold multiple times and no longer belong to the original shareholder, the reduction remains applicable whether or not the taxpayer has been informed.

Following a share repurchase, a gross-up of the PUC is necessary according to paragraph 85(2.1)(b), so that the PUC of the remaining of the shares does not change. The basis for the calculation is the PUC reduction at the time the PUC is calculated.

Cost of the property for the corporation

In general, the agreed amount according to section 85 is used to determine the cost of the property for the "taxable Canadian corporation" or the "Canadian partnership."

However, the cost of a depreciable property for the purposes of computing the CCA may be adjusted according to one of these provisions of the ITA:

i) the transferor and transferee do not deal at arm’s length
ii) the property was a capital property of the transferor

The application of paragraph 13(7)(e) or subsection 85(5) overrides any capital cost that could have been determined under section 85. For the purposes of computing capital gains, the capital cost does not change. That is, it corresponds to the agreed amount (any additional amount of recapture because of subsection 85(5) will be removed in the determination of capital gain by paragraph 39(1)(a)).

Income Tax Regulation 1100(2.2) excludes some depreciable properties from the halfyear rule if the transferor acquired and owned the property at least 364 days before the end of the transferee’s tax year in which the rollover occurred. The halfyear rule would apply only if the transferor owned the property for less than 364 days before the transferee’s yearend.

For more information on computing the acquisition cost, see Research Guide RG-41B, Capital Cost of Certain Property - 1994 and subsequent years, paragraphs 13(7)(e) and (e.1) Rules applicable, 13(7.3) Control of corporations by one trustee.

Other important issues to be considered

When a taxpayer transfers an eligible property to a taxable Canadian corporation according to section 85, these provisions must be considered:

Before deciding to apply the provisions listed above, consult Real Estate Appraisal and/or Business Equity Valuation to determine the FMV of the property transferred and the consideration. For more information, go to 10.11.4, Referrals for real estate appraisal or business equity valuation.

The value of a benefit may be reduced or cancelled if:

24.13.3 Transfer of property - Guidelines

Consideration for a transferred property

The consideration for a transferred property must include shares of the capital stock of the transferee corporation.

A rollover according to section 85 of the ITA without a share issue is not a valid election. However, following the court’s decision in Dale et al. v The Queen, 97 DTC 5252 (FCA), the CRA accepts, under certain specific conditions, elections if the issue of shares occurred after the transfer for legal reasons. According to this case, the CRA must respect the legislation of a province. Justice Robertson stated:

"If the legislature of a province authorizes its courts to deem something to have occurred on a date already past, then it is not for the Minister to undermine the legislation by refusing to recognize the clear effect of the deemed event".

The CRA accepts the elections made according to section 85  if shares given in consideration do not have to be issued in due form at the time of the transfer if:

If, for whatever reason, the transferee corporation does not obtain, according to relevant provisions of corporate law, the necessary authority to issue shares, the election made according to section 85 will be considered invalid.

24.13.4 Section 85  of the ITA - Acceptable amended election

Late or amended elections made according to subsections 85(7) or (7.1) are acceptable if the taxpayer wishes to correct errors or omissions and pays an estimate of the penalty outlined in subsection 85(8). Note that clerical errors corrected by the tax center do not require an amended election.

The CRA may recognize a price adjustment clause provided that the conditions set out in Income Tax Folio S4-F3-C1(1.5), Price Adjustment Clause, 1.5 Requirements governing the recognition of a price adjustment clause, are met.

Following an assessment and the CRA’s recognition of a price adjustment clause, the implications are the same as those mentioned in 24.10.4 section, Reimbursement policy.

A taxpayer may file an amended election without incurring a penalty if:

Ineligible amended election

Amendments to an election filed under section 85 of the ITA will not be accepted when the main objective is to:

Related subject

Go to 28.6.0, Penalties for late filed and/or amended elections under the ITA.

24.13.5 Section 85  of the ITA rollover checklist

Corporations commonly use the provisions of subsection 85(1) of the ITA, thereby electing to roll over "eligible property" in matters related to tax planning. A number of problems can result from an invalid election.

The following checklist helps to determine the validity of an election and to make the necessary adjustments under the provisions of the ITA and more specifically subsections 15(1), 69(4), 85(1), 85(2.1), and paragraph 85(1)(e.2). A separate checklist is required for each property. 

Identification
 Taxpayer:    
 Account No:    
 Case No.:  File No.:  Date:
Election
   Yes   No   WP  Ref. 
 1. Has the election been confirmed by a resolution in the minute book?      
 2. Does the agreed amount meet the various limitations of subsection 85(1)  of the ITA? If not, the agreed amount will be adjusted under paragraph 85(1)(b) to (e.4)
      
Valuation of property
   Yes   No   WP  Ref. 
 1. Is it necessary to have the transferred property or the consideration received (other than as a share) valued by Business Equity Valuation or Real Estate Appraisal? The following can be used to help determine if a referral is necessary:
    a) Agreed amount = FMV of the property
    b) Capital gains deduction claimed under section 110.6 of the ITA
    c) Net capital loss carried over to the rollover year
    d) Relatively high FMV of the rolledover property		      
 2. Is it reasonable to consider the FMV of the transferred property that exceeds the higher of the FMV of the total consideration and the agreed amount as a benefit that the taxpayer wanted to confer on a related person? If yes, paragraph 85(1)(e.2) of the ITA may apply.
      
 3. Is the FMV of the consideration received by the transferor greater than the FMV of the property transferred to the corporation? If yes, the transferor received a taxable benefit under subsection 15(1) of the ITA.      
 4. If a price adjustment clause is included in the contract of sale, does the clause meet the conditions specified in Income Tax Folio S4-F3-C1, Price Adjustment Clauses? If yes, the taxpayer could file an amended election under subsection 85(7.1) if it pertains to a valuation.      
Parties involved
   Yes   No   WP  Ref. 
 1. Is the transferee a "taxable Canadian corporation"? If not, the election is invalid.
      
 2. Did the transferor report a capital gain or business income upon sale of the transferred property?
      
 3. Did the transferor claim a terminal loss, a capital loss, or a terminal allowance under paragraph 24(1)(a) of the ITA? If yes, a loss claimed after April 26, 1995, is deferred or depreciated in an "affiliated" situation in compliance with subsections 13(21.2), 14(12), or 40(3.2) to (3.6) of the ITA.      
 4. Did the transferee report a capital gain or business income at the time of the appropriation of property to a shareholder? The proceeds of disposition are equal to the property’s FMV in compliance with subsection 69(4) of the ITA.
      
Eligible property
   Yes   No   WP  Ref.
 1. Has the transferor made an election on ineligible property? If yes, this situation has no bearing on the rest of the rollover. "Eligible property" is defined in subsection 85(1.1) of the ITA.
      
 2. Are all properties included in the contract of sale included on the prescribed form? If not, omitted property is considered property that was disposed of according to its FMV. The taxpayer could file an amended election to correct the situation.      
 3. Were shares that constituted capital property for an individual transferor, transferred to a corporation with which the transferor had a non-arm’s length relationship? If yes, consider the application of section 84.1.      
 4. Were a number of eligible properties transferred? If yes, ask the taxpayer for the order in which each eligible capital property and each depreciable property was disposed of. An analysis may be warranted.      
 5. Is the eligible property a share of capital stock for which a taxable dividend received was deducted under subsection 112(1), 112(2), or 138(6)? If yes, consider the application of subsection 55(2) of the ITA if the transaction is part of a transaction, an event, or a series of transactions or events.
      
Consideration received by the Transferor
   Yes   No   WP  Ref.
 1. Did the transferor receive shares in consideration of the transferred property? If not, the rollover is not a valid election.      
 2. Does the share ledger confirm the issue of shares by the corporation?      
 3. Was the cost of the consideration received computed in compliance with paragraphs 85(1)(f) to (h) of the ITA?
      
 4. Can the increase in paid-up capital for shares lead to a deemed dividend by applying subsection 84(1) of the ITA?
      
 5. Does the paid-up capital for shares issued need to be adjusted in compliance with section 84.1, section 212.1, or subsection 85(2.1) of the ITA?
      
Depreciable Property
   Yes   No   WP  Ref.
 1. Is the cost of the property for the transferee greater than the cost for the transferor? If yes, the maximum CCA that the transferee may claim is computed based on the cost of the property determined in paragraph 13(7)(e) of the ITA.
      
 2. Is the cost of the transferred property for the transferor greater than the agreed amount? If yes, the maximum CCA that the transferee may claim is computed based on the cost of the property determined in subsection 85(5) of the ITA.      
 3. Did the transferee claim CCA during the year of the transfer? If yes, does the half-year rule of subsection 1100(2) of the Regulations need to be applied?
      
 4. In the case of a "rental property," did the CCA claimed create a rental loss? If yes, part of the CCA claimed may be disallowed under subsection 1100(11) of the Regulations.      
 5. In the case of a passenger vehicle transferred to a related corporation, is the transferor continuing to use the vehicle for personal use? If yes, the benefit for the right of use for an automobile must be computed based on the FMV of the vehicle prior to the rollover under paragraph 85(1)(e.4) of the ITA.      
Eligible Capital Property
   Yes   No   WP  Ref.
 1. If the goodwill was transferred as part of a rollover, did the taxpayer indicate a nominal value for the goodwill generated by the business? "Nil" is not a nominal value.
      
 2. Did the transferor claim an amount as a deduction from capital gains for the disposition of an eligible capital property? If yes, the transferee’s eligible capital expenditure may be reduced under subsection 14(3) of the ITA.
      
Debts
   Yes   No   WP  Ref. 
 1. When accounts receivable are transferred to a corporation as part of the transfer of all or substantially all of the business from the transferor to the corporation:
      

a) Did the transferor incur a loss upon disposition of the accounts receivable? If yes, the loss is usually a capital loss unless the transferor is a trader in accounts receivable.

      

b) Did the transferor claim a reserve for the accounts receivable transferred? If yes, the claim is not eligible.

      

c) Did the transferee claim a reserve under paragraphs 20(1)(l) or (p) in regard to the accounts receivable acquired? If yes, the deduction cannot be claimed. However, the effect of section 22 election would have to be considered.

      
Transactions following a Rollover
   Yes   No   WP  Ref. 
 1. Did the transferee dispose of the eligible capital property following the rollover? If yes, an adjustment to the "cumulative eligible capital" may be needed under paragraph 85(1)(d.1) of the ITA.
      

 2. Did the transferee proceed with the purchase of shares issued at the time of the rollover? If yes, the reduction in paidup capital under subsection 85(2.1)(a) on the redeemed shares must be added back under subsection 85(2.1)(b) when establishing the paid-up capital of the remaining shares.

      

 3. Were the shares received by the transferor "taxable Canadian property" or capital property? The treatment of a gain realized when the shares are disposed of in the future will depend on the type of shares.

      
Conclusion
The provisions of subsection 85(1) of the ITA are met  Yes   No 
Signatures and dates
 Auditor :  Date:
   
 Team Leader :  Date:
   

Example of rollover according to subsection 85(1) of the ITA

The facts according to Form T2057, Election on disposition of property by a taxpayer to a taxable Canadian corporation :

Details of eligible property disposed:

Land                                                                     FMV                  $650,000 Footnote iii 

                                                                                      ACB                  $200,000

Details of consideration received:
       Painting                                                               FMV                   $125,000

       10 preferred shares                                          FMV/PUC          $525,000

Agreed amount:                                                                                  $200,000

Description of the preferred shares received:
       Share redemption value                                                             $  52,500

       Stated capital                                                                                $  52,500

What are the tax implications?

The solution

  1. The conditions for applying subsection 85(1) are met.
  2. The agreed amount of $200,000 satisfies the various limits.
  3. The cost of the non-share consideration (painting) = $125,000.
  4. The cost of the preferred shares = $200,000 - 125,000 = $75,000.
  5. The reduction of PUC = stated capital - (excess of agreed amount over the non-share consideration)
                                           = $525,000 - (200,000 - 125,000)
                                           = $450,000
  6. The PUC = stated capital - reduction = $525,000 - 450,000 = $75,000.
  7. The benefit the shareholder received corresponds to the difference between the FMV of the properties received and the FMV of the properties transferred, that is, ($650,000 - 500,000) = $150,000.
  8. Subsection 84(1) does not give rise to a deemed dividend since the net increase in the value of the assets ($500,000 - 125,000 = $375,000) is greater than the increase in the PUC of the shares ($75,000).
  9. The benefit to include in the shareholder’s income according to subsection 15(1) is $150,000 ($650,000 - 500,000 - 0 (deemed dividend)). This benefit may be reduced or offset subject to the CRA’s reimbursement policy in 24.10.4.
  10. The ACB of the preferred shares received is increased by the benefit under subsection 52(1).
  11. The taxpayer may submit an amended Form T2057 and pay the penalties provided a price adjustment clause was filed with the original Form T2057.
  12. The auditor considers waiving any penalty according to subsection 220(3.1).

References

Income Tax Folio

Income Tax Interpretation Bulletins

Income Tax Information Circular

Other

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