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 Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
1.application of 15(2)(a)(ii) where shareholder had other financing to purchase farm land contiguous to house for shareholder's habitation
2.assuming that 15(2) doesn't apply, is the loan a home purchase loan for the purpose of fixing a ceiling on the prescribed rate amount
Position TAKEN:
1.the exception in 15(2)(a)(ii) applies to the loan from the corporation which was used solely to acquire the farmhouse because the matching principal in 12(1)(c) doesn't apply for the purpose of 15(2)
2.clarified that this loan is likely not a home purchase loan because it is more likely that the loan was granted in their capacity as shareholders rather than as employees. However, the bulletin is wrong in the implication that an entire loan would be a home purchase loan if only a portion of the loan was used to acquire the dwelling.
Reasons FOR POSITION TAKEN:
1.There is no authority to prorate the income inclusion under 15(2). The purpose test in 15(2) differs from the purpose test in determining whether an amount is deductible as interest.
2.the error in the bulletin was due to stylistic changes in version 3A of IT-421R2
March 30, 1994
KITCHENER DISTRICT OFFICE HEAD OFFICE
Dick Beech Rulings Directorate
Chief of Audit A. Humenuk
957-8953
Attention: Wayne Hoogsteen
933613
Shareholder Loan used to acquire Farm Property with Residence
We are replying to your memorandum of December 2, 1993 concerning an audit of XXXXXXXXXX.
The taxpayers financed the purchase of their farm with an interest-free shareholder loan from their company of $XXXXXXXXXX and a first mortgage of $XXXXXXXXXX held by a financial institution. Your first question is whether all or part of the shareholder loan is required to be included in income under subsection 15(2) of the Act. You cite various court cases (Wong v MNR 90 DTC 1710, Lee v MNR 89 DTC 443) dealing with the deductibility of mortgage interest in support of your position, which is that each of the two loans must be allocated between the business and personal use for the purpose of determining whether the shareholder loan, or portion thereof, can be excluded from income by reason of subparagraph 15(2)(a)(ii) of the Act.
In our telephone conversation of January 20, 1994 (Hoogsteen/Humenuk), you advised that you proposed to include in income under subsection 15(2) of the Act that portion of the shareholder's loan which was not allocatable to the principal residence because that portion of the loan did not, in your view, meet the criteria set out in subparagraph 15(2)(a)(ii) of the Act. The taxpayers objected on the basis of paragraph 16 of Interpretation Bulletin IT-119R3. The bulletin states that where the loan is used to acquire a property which is used partially as a residence and partly for the purpose of gaining income from a business, subparagraph 15(2)(a)(ii) of the Act will apply to exclude the loan from income provided that the value of the loan does not exceed the cost of the house and the proportionate amount of land which is reasonably required for the use and enjoyment of that residence and bona fide arrangements were made at the time the loan was made for the repayment thereof within a reasonable period of time. You ask us to confirm your views and request that the bulletin be amended to reflect this position.
In the event that all or part of the shareholder's loan is excluded from income by reason of subparagraph 15(2)(a)(ii) of the Act, an interest benefit as determined by section 80.4 of the Act will be included in income of the taxpayers on that portion of the loan which is not included in income. You ask for clarification as to how to calculate the deemed interest benefit where only a portion of the loan was used to acquire the dwelling and land reasonably required for the use and enjoyment thereof. Your concern arises from the fact that paragraph 80.4(7)(a) of the Act defines a home purchase loan in part, to mean "that portion of any loan ..." used to acquire a dwelling for the habitation of the borrower or a related person whereas the reference in paragraph 19 of Interpretation Bulletin IT-421R2 is to "any portion of that loan ..." used to acquire a dwelling for that purpose. Your understanding of the definition of a home purchase loan is that it is restricted to the portion of the total loan which is used to acquire a dwelling for the purpose stated therein and that the ceiling on the prescribed rate to be used to determine the benefit will only apply to that portion of the loan so used. However, a home purchase loan as described in the bulletin would appear to include the entire loan provided that any portion of the loan is used to acquire the dwelling for the habitation of the individual who borrows the funds.
The taxpayers have agreed to a fair market value allocation between the principal residence and 1/2 hectare of land ($XXXXXXXXXX) and the balance of the farmland ($XXXXXXXXXX) based on the purchase price of the property. For the purpose of our response we will assume that the shareholders were also employees of the corporation, the dwelling was acquired for their habitation and bona fide arrangements were made at the time the loan was made for the repayment thereof within a reasonable period of time.
In the comments that follow, unless otherwise stated, all statute references are to the Income Tax Act S.C. 1970-71-72, c.63 as amended, consolidated to June 10, 1993 (the "Act").
Subsection 15(2) of the Act requires a shareholder to include in income the entire amount of any loan received from the corporation unless that loan meets one of the exceptions noted therein. The purpose of this provision is to prevent dividends from being paid out in the guise of loans. The absence of language such as "to the extent that" or "that portion of" suggest that it is not appropriate to apportion a part of the loan to be included in income. As stated in paragraph 13 of IT-119R3, the whole amount of the loan or indebtedness must meet the criteria described in that paragraph in order for it to be excluded from income.
Subparagraph 15(2)(a)(ii) of the Act does not make a specific link between the cost of the dwelling and the amount of the loan. The requirement in paragraph 16 of IT-119R3 that the amount of the loan not exceed the cost of the dwelling and that portion of the land reasonably required for its use and enjoyment serves to determine whether it is reasonable to assume that the purpose of the loan was to enable the employee to acquire the dwelling which he or she inhabits or whether the loan serves multiple purposes. Where a specific loan exceeds the amount used for a qualified purpose, the entire amount of the loan will be included in income under subsection 15(2) notwithstanding that a part of the loan was used for a qualified purpose as stated in paragraph 13 of IT-119R3.
It is your view that, based on the court cases cited above, the apportionment rule used to determine what portion of mortgage interest is deductible under paragraph 20(1)(c) of the Act is applicable for the purpose of determining whether subsection 15(2) applies to a particular loan. We disagree. As stated above, the exceptions in subsection 15(2) will only apply if the entire loan is used for a qualified purpose. Any allocation of the loan between that portion of the loan which is applicable to the residence and that portion which is applicable to the balance of the property would taint the entire loan. For example, if the corporation had loaned the individual only $10,000 to assist in the acquisition of a residence and the employee had used the funds to acquire the farm and dwelling, an allocation of the $10,000 between farmland and dwelling would cause the $10,000 to be included in income because a portion of the loan was applicable to the farm land. Consequently, it is our view that the court cases cited above are not applicable in determining whether a particular shareholder loan can be excluded from income by reason of subparagraph 15(2)(a)(ii) of the Act.
This is not to say that we dispute the allocation of a loan between income producing property and non-income producing property for the purpose of paragraph 20(1)(c) of the Act. The reason for determining the purpose of the loan differs between the two provisions; paragraph 20(1)(c) of the Act requires an allocation of each loan used to acquire the property in order to properly match the interest expense to the revenue earned whereas subparagraph 15(2)(a)(ii) of the Act requires a determination of the purpose of the loan in order to decide whether the circumstances under which the shareholder loan is granted is sufficiently similar to the situation where a corporation lends its employee funds to assist with the acquisition of a residence. Consequently, the purpose test found in subparagraph 15(2)(a)(ii) of the Act is not affected by the fact that the shareholder-employee must find another source of financing if he or she wishes to acquire a property of greater value than the amount of the shareholder loan.
In the case of the XXXXXXXXXX they acquired one property for $XXXXXXXXXX which included a farm and a dwelling for their habitation. The $XXXXXXXXXX loan certainly assisted them in acquiring that property and since the amount of the corporate loan did not exceed the cost allocated to the dwelling and surrounding land necessary for the use and enjoyment thereof, there is no reason to suggest that the corporation lent them the funds for some other purpose.
With respect to your question on the definition of a home purchase loan found in paragraph 80.4(7)(a) of the Act, it is relevant to note that a loan will only qualify as a home purchase loan if, among other criteria, it is conferred on the individual by reason of a previous, current or intended office or employment of a person. As stated in paragraph 13 of Interpretation Bulletin IT-421R2, it is a question of fact as to whether a loan to an employee-shareholder is granted by reason of employment or shareholdings. However, based on the information provided to us, it seems unlikely that any portion of the $XXXXXXXXXX loan to the XXXXXXXXXX could be considered to be a loan granted by virtue of their employment with the corporation.
Nevertheless in a situation where a loan is granted by virtue of an individual's employment and only a portion of that loan is used to acquire a dwelling for the habitation of the borrower, we agree that the amount of the home purchase loan is restricted to the portion so used. In determining the portion of the loan which qualifies as a home purchase loan, the Department includes the subjacent and immediately contiguous land which would qualify as part of the principal residence if it were so designated. Our research into the source of the phraseology used in paragraph 19 of Interpretation Bulletin IT-421R2 suggests that the difference arose because of stylistic changes made to make the paragraph more readable. We have advised Technical Publications Division accordingly.
P.D. Fuoco
Section Chief
Personal and General Section
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch
c.c. Technical Publications Division
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