15 August 2012 External T.I. 2012-0443581E5 - Shareholder Loans

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.

Principal Issues: What is the meaning of "a series of loans or other transactions and repayments" under subsection 15(2.6)?

Position: A "series" is generally restricted to a repayment shortly before the year-end of the corporation and the same amount, or substantially the same amount, is borrowed shortly thereafter in the immediately following year.

Reasons: CRA policy based in case law.

XXXXXXXXXX
2012-044358
Andrea Boyle, CGA
August 15, 2012

Dear XXXXXXXXXX:

Re: Shareholder Debt

I am writing in reply to your email dated April 11, 2012 in which you have asked us the meaning of “a series of loans or other transactions and repayments” under subsection 15(2.6) of the Income Tax Act. You have asked whether an income inclusion is required under subsection 15(2) under specific circumstances.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. We are, however, prepared to offer the following general comments, which may be of assistance.

All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended.

Subsection 15(2) generally requires a shareholder to include in income the amount of any loan received or indebtedness incurred from a corporation unless the loan or indebtedness is specifically excluded through other provisions.

Under subsection 15(2.6), a loan or indebtedness may be excluded from income if it is repaid within one year after the end of the taxation year (of the lender or creditor corporation) in which the loan was made or the indebtedness arose where it is established that the repayment was not part of “a series of loans or other transactions and repayments”. An indebtedness that is considered part of a “series” will therefore not qualify for the exemption under subsection 15(2.6) and, unless it is excluded under another provision, must be included in income without waiting one year for possible repayment.

The CRA’s current position is that a “series” is generally restricted to a situation where a repayment is made shortly before the year-end of the corporation and the same amount, or substantially the same amount, is borrowed shortly thereafter in the immediately following year. This payment is not considered by the CRA to be a legitimate repayment.

Therefore, if, at the end of a taxation year, a shareholder has a debit balance in his or her account and a cash payment is made to be withdrawn again at the beginning of the following year, this repayment would be considered to be temporary and would be considered part of a series of loans and repayments.

Generally speaking, repayments in a given fiscal period are applied to the oldest outstanding indebtedness of the shareholder unless the facts clearly indicated otherwise (i.e. where the shareholder has specifically allocated payments on another basis and has communicated this to the corporation).

In the situation which you have described, we assume that the taxation year of the corporation which includes the date on which the indebtedness arose is the 2010 taxation year (i.e. the indebtedness arose during the period from September 1, 2009 to August 31, 2010).

In this situation, the shareholder would have one year from August 31, 2010 (i.e. until August 31, 2011) to make a repayment. Any part of the indebtedness that remains outstanding on September 1, 2011 will be brought into the shareholder’s income under subsection 15(2) in the year in which the indebtedness arose. That is, the debt is potentially taxable in the shareholder’s 2009 or 2010 taxation years depending upon when the original components of the indebtedness arose.

It is a question of fact whether or not a repayment made during the corporation’s 2011 taxation year would be a “series” or whether the shareholder has specifically directed that the repayments should be allocated on some other basis than against oldest indebtedness first. However, assuming that neither of these situations applies, it is likely that the repayments made in 2011 (which, in the circumstances described, exceed the balance owing at the end of the 2010 taxation year) could be applied first against that 2010 indebtedness and therefore there would be no income inclusion required under subsection 15(2).

However, it should be noted that, where the indebtedness is not included under subsection 15(2), the shareholder would be subject to a taxable interest benefit calculated under section 80.4(2) for the number of days that the amounts remained owing each year. The interest benefit would be calculated as the amount, if any, by which the interest on the debt computed at the prescribed rate exceeds the amount of the interest actually paid by the shareholder not later than 30 days after the end of the corporation’s taxation year.

We trust that these comments will be of assistance.

Yours truly,

Doug Watson
for Director
Corporate Financing Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch