Potential application of s. 15(2.17) where corporation guarantees loan to individual shareholder (p. 1)
[T]he back-to-back loan rules…may have an unintended consequence for individual shareholders of a CCPC who borrow money from a third party. Pursuant to subsection 15(2.17), if the corporation guarantees a loan obtained by one of its shareholders (or a connected individual) from a third party and pledges property as security, the loan can be deemed to be a loan made directly from the corporation to the individual shareholder, causing a subsection 15(2) income inclusion for the individual shareholder….
Specified right issue: can pledged property only be applied to repay shareholder debt
In general terms, the back-to-back loan rules in subsections 15(2.16) to (2.192) apply (causing the subsection 15(2) income inclusion) when a funder is owed an amount under a funding arrangement by an individual shareholder of a Canadian-resident corporation and the existence of a specified right is required under the terms of the funding arrangement. ... "Specified right" is defined…as a right to (1) mortgage, hypothecate, assign, pledge, or in any way encumber the property to secure payment of an obligation other than the shareholder debt, or (2) use, invest, sell, or otherwise dispose of, or in any way alienate, the property unless all of the net proceeds from doing so are used to repay the shareholder debt. The key consideration is that the secured property in question can be used only to repay the shareholder debt (which is defined in paragraph 15(2.16)(a)). [But see Lorito.]
Standard loan provisions creating a specified right problem (pp. 1-2)
[M]ost guarantees and related security agreements contain broad language that covers not just the present debt but also any future indebtedness of the individual shareholder. Because of this breadth of coverage, a specified right arises, and with it the tax problem.
In certain circumstances, a single security document (given by the corporation to the third party) can cover both (1) the individual shareholder's loan from the third party and (2) an existing operating loan given by the third party to the corporation. Because the single security document covers more than just the individual shareholder's loan, a specified right arises.
A secured guarantee by a private corporation of a bank loan to its individual shareholder may very well cause an income inclusion to the individual under the s. 15(2.17) back-to-back loan rules. In order for the bank not to have a specified right, the key consideration is that the secured property can be used only to repay the shareholder debt. However (p.1):
[M]ost guarantees and related security agreements contain broad language that covers not just the present debt but also any future indebtedness of the individual shareholder. Because of this breadth of coverage, a specified right arises, and with it the tax problem.
In addition (pp. 1-2):
In certain circumstances, a single security document (given by the corporation to the third party [e.g., bank]) can cover both (1) the individual shareholder's loan from the third party and (2) an existing operating loan given by the third party to the corporation. Because the single security document covers more than just the individual shareholder's loan, a specified right arises.
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