18 July 1988 Income Tax Severed Letter 5-6106 - [Loan to a Shareholder]

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.

J.D. Jones (613) 957-2104 JUL 18 1988

Dear Sirs:

Re: Loan to a Shareholder

This is in reply to your letter of May 26, 1988 in which you requested the Department's opinion as to whether or not the provisions of subsection 15(2) or 6(3) or paragraph 6(1)(a) of the Income Tax Act (the "Act") apply to the situation as outlined in the above noted correspondence.

It is our understanding that the facts as outlined in your letter of May 26, 1988 may be summarized as follows:

Mr. A, a Canadian resident, is employed as the president of B Co., a Canadian controlled private corporation. Mr. A and B Co. deal at arm's length. On the commencement of his employment in 1985, Mr. A entered into an agreement with B Co. which granted to Mr. A the right to purchase shares of the corporation at a specified price. The agreement was granted to Mr. A as a separate inducement in connection with his employment and not in lieu of salary or other remuneration. The agreement provides for B. Co. to loan to Mr. A an amount equal to the purchase price of the shares to be used in the purchase of the shares. Mr. A is to repay the loan from dividends paid by B. Co. or from proceeds on the sale of the shares upon termination of his employment. If on Mr. A's termination of employment the remaining loan balance exceeds the sales proceeds of the shares the excess amount will be forgiven. The loan is not interest bearing except to the extent that repayments of one-fifth of the purchase price are not made on December 31 in each of the years 1985 to 1989 inclusive.

In 1985 Mr. A exercised all of his rights under the agreement and became indebted to B Co. for the amount of the purchase price.

Mr. A does not own and has never owned any other shares of the company nor has B Co. made any other loans to any other shareholder or employee. B Co. paid its first dividend in February 1986 and the amount received by Mr. A as a dividend wee applied to the loan outstanding from B Co. To date no other dividends have been declared and no other repayments of the loan have been made by Mr. A who understands that a benefit may be included in his income pursuant to section 80.4 of the Act.

Based on the situation as outlined above, our responses are in the order in which the questions were asked.

1. In our view, subsection 15(2) of the Act could only apply if Mr. A. received the loan in his capacity as shareholder. Whether or not Mr. A. received the loan in his capacity as an employee or as a shareholder is a question of fact about which we are not in a position to come to a conclusion without knowing all of the relevant facts of a particular situation.

2. In the event that subsection 15(2) of the Act did not apply, it would appear that no portion of the principal amount of the loan would be included in Mr. A's income under either paragraph 6(1)(a) or subsection 6(3) of the Act, other than by virtue of the forgiveness of the loan, in which case paragraph 6(1)(a) of the Act would bring into income the amount of any such loan or indebtedness forgiven.

3. In the event the Department considered the loan to be a shareholder loan subject to subsection 15(2) of the Act, it would appear that the loan may qualify as an exception under subparagraph 15(2)(a)(iii) of the Act to an inclusion in income.

We hope that this letter will be of assistance to you. We would also stress that this is not a ruling and is not binding upon the Department.

Yours truly,

ORIGINAL SIGNED BY

P.D. FUOCO for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch