Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues : Refinancing of prescribed rate loan
Position TAKEN: Not enough information- A factual determination
REASON FOR POSITION TAKEN: Novation? and Wording of 74.1(3)
2002-014398
XXXXXXXXXX C. Tremblay, CMA
(613) 957-2139
October 18, 2002
Dear XXXXXXXXXX,
Re: Refinancing of Prescribed Rate Loan
This is in reply to your letter of May 31, 2002 wherein you request a technical interpretation regarding a refinancing of a loan between spouses and between a parent and a trust at prescribed rates.
In your example, a husband loans $100,000 to his wife during a period in which the prescribed rate was 5% and the loan is subsequently repaid and replaced immediately thereafter with a new prescribed rate loan at 2%. In order to arrange the repayment of the original loan, cheques would be written to pay off the first loan. Later the following day, funds would be advanced to the spouse documented by a new loan agreement at the prescribed rate in effect at that time (2% currently). You also question whether or not the same refinancing of loans would be treated any differently if the loan were made to a Trust benefiting minor children instead of directly to a spouse.
The particular situation outlined in your letter appears to relate to a factual situation involving specific taxpayers. As explained in Information Circular 70-6R5, it is not our practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a transaction that is already in progress, you may wish to submit all relevant facts and documentation to the appropriate Tax Service Office for their views. However, we are prepared to offer the following general comments, which may be of assistance to you.
Where an individual loaned funds to his or her spouse and charged interest at the prescribed rate in effect at the time the loan was made and the loan was as described in subsection 74.5(2) of the Income Tax Act (the "Act"), the income from the property acquired with the borrowed funds would not be subject to the attribution rules. However, depending on the particular facts, the exception in subsection 74.5(2) of the Act may cease to be applicable at the time the second loan was made, and the attribution rules in subsections 74.1(1) and (2) of the Act would then apply by virtue of subsection 74.1(3) of the Act.
The exemption from attribution is generally available on a year-to-year basis. It is a question of fact whether the second loan is a new loan or whether the original loan has been repaid. Generally, we would need to review the terms of the previous loan and the particular source of funds that in fact repay that loan before we can make a definite reply.
However some guidance can be obtained from considering the case law relating to novation. In Prospect Mortgage v. Van-5 Developments Limited [1985] B.C.J. No. 2472 Mr. Justice Esson, speaking for the British Columbia Court of Appeal, said:
"Because novation is essentially an issue of fact, it would be wrong in principle to say, as a generalization, that assumption agreements or extension agreements, or other particular classes of documents, do or do not create a novation. The question must be decided in each case having regard to all circumstances of which the language of the new contract is only one."
This statement was quoted with approval by Madam Justice Wilson in National Trust v. Mead [1990] 2 S.C.R. 410 at page 432, who confirmed that novation is a question of fact.
Accordingly, the resolution of your question would require an analysis of all of the pertinent facts surrounding the new loan. Also, the possible application of subsection 74.5(11) of the Act would depend on these facts. Accordingly, we are unable to provide a definitive response by way of general interpretation.
We would be pleased to consider these questions in the context of an advance income tax ruling.
Steve Tevlin
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation
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