What the "Archived Content" notice means for interpretation bulletins

NO: IT-119R4

DATE: August 7, 1998

SUBJECT: INCOME TAX ACT
Debts of Shareholders and Certain Persons Connected With Shareholders

REFERENCE: Subsection 15(2) (also subsections 15(1), 15(1.2), 15(2.1) to (2.7), 15(7), 15(9), 212(2), 214(3) and 227(6.1), 248(1) definitions of "foreign affiliate" and "specified employee" and paragraph 20(1)(j))

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Contents

• Application
• Summary
• Discussion and Interpretation
  • General (¶s 1-6)
  • Exceptions: Loans Made for Specific Purposes
    • General (¶s 7-14)
    • Trade Debts (¶ 15)
    • Revolving Debt (¶ 16)
    • Dwelling (¶s17-19)
    • Acquisition of Shares (¶ 20)
    • Acquisition of a Motor Vehicle (¶ 21)
  • Employee and Specified Employee (¶s 22-23)
  • Exception: Repayment Within One Year (¶s 24-27)
  • Whether Repayment Is Part of a Series of Loans or Other Transactions and Repayments (¶s 28-29)
  • Deduction of Repayment if Not Part of a Series (¶s 30-33)
  • Application of Subsection 15(2) and Paragraph 20(1)(j) When "a Series" (¶s 34-36)
  • Non-Residents (¶s 37-41)
• Explanation of Changes

Application

This bulletin cancels and replaces Interpretation Bulletin IT-119R3, dated October 12, 1984, and the Special Release thereto dated March 31, 1987.

Summary

Shareholders are generally taxable on amounts received from a corporation. The purpose of subsection 15(2) is to include in a shareholder's income amounts received from a corporation in the guise of loans or other indebtedness, with specific exceptions provided in the law.

This bulletin discusses the tax implications to a person or partnership who is a shareholder of a corporation, connected with a shareholder of the corporation, or who owns shares of the corporation through a partnership or trust, of a loan or indebtedness from that corporation, a related corporation or a partnership of which that corporation or a related corporation is a member. It comments on the factors that determine whether or not the loan or indebtedness must be included in the income of the debtor and on the timing of such inclusion. It also discusses the deductibility of repayments and the effect of a series of loans and repayments.

Discussion and Interpretation

General

¶ 1. A person or partnership, described in ¶ 2 below, that has in a taxation year received a loan from or become indebted to

(a) a particular corporation;

(b) any other corporation related to the particular corporation; or

(c) a partnership of which the particular corporation or a related corporation is a member,

will be required to include the amount of the loan or indebtedness (hereinafter referred to as the "loan") in income for that year under subsection 15(2), unless the loan comes within the exceptions discussed in this bulletin. An entity described in (a), (b), or (c) is referred to herein as the "lender" or "creditor," depending on the circumstances. Loans that are not subject to subsection 15(2) may give rise to a benefit included in income under subsection 15(1) pursuant to subsection 15(9), if no interest or a low rate of interest is charged. For comments concerning taxable benefits arising from interest-free or low-interest loans, see the current version of IT-421, Benefits to Individuals, Corporations and Shareholders from Loans or Debt.

¶ 2. The "person or partnership" referred to in ¶ 1 above is a person (other than a corporation resident in Canada) or a partnership (other than a partnership each member of which is a corporation resident in Canada) that is

(a) a shareholder of the particular corporation in ¶ 1(a) above;

(b) connected with a shareholder of the particular corporation (see ¶ 5 below); or

(c) a member of a partnership, or a beneficiary of a trust, that is a shareholder of the particular corporation.

An entity referred to in (a), (b), or (c) is referred to herein as the "borrower" or "debtor," depending on the circumstances.

¶ 3. Section 251 provides the rules for determining when corporations are related (see ¶ 1(b) and (c) above) and is discussed in the current version of IT-419, Meaning of Arm's Length.

¶ 4. The phrase "a taxation year," in subsection 15(2), refers to that of the borrower. The date on which a loan was made determines the taxation year of the borrower in which the loan is included in income under this subsection. For example, if subsection 15(2) applies to a loan that a corporation makes to an individual on November 30, 1995, and the loan falls in the corporation's taxation year ending on June 30, 1996, the loan will be included in the individual's 1995 income. If the borrower is a partnership, the phrase "a taxation year," in subsection 15(2), means the fiscal period of the partnership. Similarly, when the lender is a partnership, the phrase "the taxation year" referred to in subsection 15(2.6) means the fiscal period of that partnership.

¶ 5. Subsection 15(2.1) provides that, with two exceptions, all persons who do not deal at arm's length with a shareholder of a particular corporation are "connected" with that shareholder for the purposes of subsection 15(2). The two exceptions are a foreign affiliate of the particular corporation or a foreign affiliate of a person resident in Canada with which the particular corporation does not deal at arm's length. The definition of "foreign affiliate" in subsection 95(1) applies for the purposes of subsection 15(2.1). For further information on whether or not persons are dealing at arm's length, see the current version of IT-419, Meaning of Arm's Length.

¶ 6. When a loan or other obligation of a shareholder to a corporation is settled or extinguished by payment of less than the amount of the obligation outstanding, or by no payment, subsection 15(1.2) determines the value of the benefit that is to be included in the shareholder's income under subsection 15(1). Subsection 15(1.2) deems the value of the benefit to be the "forgiven amount" at the time the loan was settled or extinguished, the "forgiven amount" being defined in subsection 15(1.21). See the current version of IT-432, Benefits Conferred on Shareholders, for a discussion of subsection 15(1.2).

Exceptions: Loans Made for Specific Purposes

General

¶ 7. If a borrower can establish that a loan falls within the provisions of one of subsections 15(2.2) to (2.6), the loan will not have to be included in income under subsection 15(2). The provisions of subsection 15(2.3) to (2.5) provide for exceptions to including loans in income when the loan is provided for a specific purpose whereas subsections 15(2.2) and (2.6) simply provide that subsection 15(2) does not apply to loans when certain circumstances exist. Subsection 15(2.2) is described in ¶ 37 below, while subsections 15(2.3) to (2.5) are discussed in ¶s 8 to 23 below and subsection 15(2.6) is discussed in ¶s 24 to 29 below.

While a written agreement is the preferable means of establishing that a loan exists, a written agreement is not necessary; however, in its absence there must be convincing evidence that a loan exists. Such evidence could include a corporate resolution setting out the loan, the terms of its repayment and such a corporate resolution should be reflected in the financial statements of the corporation.

¶ 8. The exception in subsection 15(2.3) applies when the loan is made to borrowers (whether or not they are employees) if the loan is made in the ordinary course of the lender's business (see ¶s 15 and 16 below) and bona fide arrangements were made, at the time the loan was made, for repayment within a reasonable time (see ¶ 12 below).

¶ 9. The exception in subsection 15(2.4) applies when the loan is made to:

(a) an individual who is an employee of the lender but not a specified employee of the lender (see ¶s 22 and 23 below), pursuant to paragraph 15(2.4)(a);

(b) an individual who is an employee of the lender or is the spouse of an employee of the lender to acquire a dwelling (see ¶s 17 to 19 below), pursuant to paragraph 15(2.4)(b);

(c) an employee to acquire previously unissued fully paid shares of a corporation (see ¶ 20 below), pursuant to paragraph 15(2.4)(c); or

(d) an employee to acquire a motor vehicle to be used in the performance of the employee's job (see ¶ 21 below), pursuant to paragraph 15(2.4)(d);

where

(e) for loans made after April 25, 1995, it was reasonable to conclude that the employee or the employee's spouse received the loan because of the employee's employment and not because of any person's shareholdings, and

(f) at the time the loan was made, bona fide arrangements were made for repayment of the loan within a reasonable time (see ¶ 12 below).

For the purposes of paragraph 15(2.4)(e), as described in (e) above, a loan is considered to have been made after April 25, 1995, if the funds are advanced to the borrower after that date.

¶ 10. The exception in subsection 15(2.5) applies when a loan is made in respect of a trust, if all the following conditions are met:

(a) the lender is a private corporation;

(b) the corporation is the settlor and sole beneficiary of the trust;

(c) the sole purpose of the trust is to facilitate the purchase and sale of the shares of the corporation or a related corporation at their fair market value from or to the employees of the corporation or the related corporation (other than, for loans made after June 19, 1996, to employees who are specified employees of the corporation or of a related corporation); and

(d) at the time the loan was made, bona fide arrangements were made for repayment of the loan within a reasonable time (see ¶ 12 below).

¶ 11. Whether or not a loan made by a corporation to an individual is considered to have been received by that individual in his or her capacity as an employee or as a shareholder involves a finding of fact in each particular case. When a public corporation makes a loan to a shareholder on the same terms and conditions as to other employees who are not shareholders, the loan is normally considered to be a loan received by virtue of that individual's office or employment rather than his or her shareholdings. However, when the opportunity to borrow funds is only made available to shareholders or when the terms and conditions attached to loans to employee-shareholders are more favourable than those attached to loans to other employees, the loan will be considered to have been made to the employee-shareholder in his or her capacity as a shareholder unless the facts clearly indicate otherwise.

¶ 12. In considering whether any arrangements for repayment were bona fide, the extent to which the arrangements have been carried out by the borrower is reviewed and, if the borrower is in default, any unusual circumstances that might have hindered them from being carried out. Whether or not the period allowed for repayment is "within a reasonable time" is a question of fact. In a given situation, one of the factors considered in determining what is a reasonable time is the normal commercial practice which would prevail in a similar situation. For example, for a housing loan, normal commercial practice requires the borrower, among other things, to give the lender some security (not necessarily a mortgage) and to repay any balance on the loan should the property be sold while an amount is still owing.

¶ 13. As noted in ¶ 8 above, the exception in subsection 15(2.3) applies to loans made to borrowers whether or not they are employees, whereas the exceptions in subsection 15(2.4) apply when the borrowers are also employees of the lender or, in the case of paragraph 15(2.4)(b) relating to the acquisition of a dwelling, the spouse of such an employee. The exception in paragraph 15(2.4)(c), relating to the acquisition of shares, also applies to loans made to an employee of a corporation related to the lender.

¶ 14. The exceptions in paragraphs 15(2.4)(b) to (d) apply only if a specific loan was made for a qualified purpose described in one of those provisions and is used for that purpose. If a borrower also has other loans that do not qualify for one of these exceptions, the borrower must be able to prove that the part of the total balance of loans, that was used for a qualified purpose, meets all of the conditions necessary to qualify for that exception. This would normally require that any loan which qualifies for one of the exceptions in paragraphs 15(2.4)(b) to (d) be maintained in a separate account.

Trade Debts

¶ 15. Trade debts that are accounted for separately and that arise in the ordinary course of business from the sale of goods by the creditor to a debtor, on the same terms for payment as sales to other customers of the creditor, will not be subject to subsection 15(2) (provided those terms are complied with) because of the exception in subsection 15(2.3). When trade debts are not paid according to the creditor's normal terms of payment, but such debts are settled within 12 months of being incurred, bona fide arrangements are considered to have been made at the time the indebtedness arose.

Revolving Debt

¶ 16. An individual may have revolving debt, for example, a line of credit or a charge card, with a financial institution and may own shares in the institution or be connected with someone who owns shares in the institution. Subsection 15(2.3) will be considered to apply if the terms and conditions attached to the revolving debt for the individual are the same as for a member of the public at large who does not own, or is not connected with someone who owns, shares in the institution.

Dwelling

¶ 17. Subject to meeting the requirements in paragraphs 15(2.4)(e) and (f), as described in 9(e) and (f) above, paragraph 15(2.4)(b) provides an exception if the loan is made to an employee or an employee's spouse to enable or assist the individual to acquire a dwelling for the individual's habitation. Subsection 252(4) expands the meaning of "spouse" to include certain common-law couples. The word "dwelling" includes a house, an apartment in a duplex or apartment building, a condominium, a cottage, a mobile home, a trailer, or a houseboat as well as a share of the capital stock of a cooperative housing corporation acquired for the sole purpose of acquiring the right to inhabit a dwelling owned by the corporation. The dwelling need not be located in Canada nor need it be the principal residence, as defined in section 54, of the employee or spouse. The employee or spouse who incurred the loan must actually inhabit the dwelling unless exceptional circumstances intervene, such as death, illness, fire, or transfer of the employee or spouse to another locality. The exception in paragraph 15(2.4)(b) will not apply to a loan made, as referred to therein, that exceeds the amount that is the cost to the employee or the employee's spouse for the dwelling. For example, when the employee or the employee's spouse acquires a property that consists of two or more self-contained housing units, only one of which is inhabited by the individual, the exception in paragraph 15(2.4)(b) will apply only if the loan is no greater than the proportionate cost of the one housing unit so inhabited. Similarly, if the employee or the employee's spouse acquires a tract of land on which is located a house that the individual inhabits, the exception in subparagraph 15(2.4)(b) will apply only if the loan is no greater than an amount that is the aggregate of the cost of the house itself and the proportionate cost of an area of the land that is reasonably required for the use and enjoyment of the house.

¶ 18. Whether a loan has been made to "enable or assist" an employee or an employee's spouse to acquire a dwelling is a question of fact. A loan made for the purpose of refinancing an indebtedness that was incurred earlier to acquire a dwelling is not considered to have been made to enable or assist an employee or an employee's spouse to acquire a dwelling. However, there is an exception when commitments are made at the time of the acquisition, between the employee or the employee's spouse and the lender to the effect that the lender would provide the permanent financing. In determining whether such commitments were made, all relevant facts and evidence will be considered, including formal documentation of the commitment, the nature of the original financing which should have the characteristics of usual interim financing and the reasons why the lender did not provide the original financing. As an example, the exception would apply where Mr. E, an employee, wrote to his employer to request that the employer provide interim and long-term financing for a house that Mr. E was having built for his habitation and the employer responded in writing to advise that it would provide long-term financing after Mr. E had taken possession of the house but was unable to provide the interim financing because the Board of Directors required that all housing loans be secured by registered mortgages.

¶ 19. Loans made in respect of repairs, alterations, renovations, or additions made to a dwelling are not considered to qualify for the exception under paragraph 15(2.4)(b).

Acquisition of Shares

¶ 20. Subject to meeting the requirements in paragraphs 15(2.4)(e) and (f), as described in 9(e) and (f) above, where the lender is a corporation, paragraph 15(2.4)(c) provides an exception if the loan was made in respect of an employee of the corporation, or of a related corporation, to enable or assist the employee to acquire fully paid shares of the corporation or a related corporation, from the corporation or related corporation. The shares so acquired by the employee must be previously unissued shares to be held by the employee for the employee's own benefit. While there is no specified length of time that an employee must hold the shares in order for the loan to be exempt under paragraph 15(2.4)(c), a subsequent disposition of the shares (including a disposition to a corporation in which the employee holds shares) before the loan is repaid, will generally be indicative of a purpose other than the acquisition of shares to be held by the employee for the employee's own benefit.

Acquisition of a Motor Vehicle

¶ 21. Subject to meeting the requirements in paragraphs 15(2.4)(e) and (f), as described in 9(e) and (f) above, paragraph 15(2.4)(d) provides an exception if the loan was made to enable or assist an employee to acquire a motor vehicle to be used by the employee in the performance of the duties of the employee's office or employment.

Employee and Specified Employee

¶ 22. An "employee" is defined in subsection 248(1) to include an officer; consequently, a director of a corporation is an employee. In subsection 248(1), a "specified employee" of a person is defined as an employee of the person who is a specified shareholder of the person or who does not deal at arm's length with the person. A "specified shareholder" of a corporation means a taxpayer who owns, directly or indirectly, not less than 10% of the issued shares of any class of the capital stock of the corporation or of any other corporation that is related to the corporation.

¶ 23. Subsection 15(2.7) provides that for the purposes of section 15, an individual who is an employee of a partnership is deemed to be a specified employee of the partnership where the individual is a specified shareholder of one or more corporations that, in total, are entitled, directly or indirectly, to not less than a 10% share of any income or loss of the partnership.

Exception: Repayment Within One Year

¶ 24. Subsection 15(2.6) provides that if the loan is repaid within one year from the end of the taxation year of the lender in which the loan was made and if the repayment is not part of a series of loans or other transactions and repayments (see ¶s 28 and 29 below), the loan is not included in the income of the borrower under subsection 15(2).

¶ 25. The giving of a promissory note by a borrower or the assumption of the loan by another person does not constitute repayment of a loan received by that borrower.

¶ 26. A loan need not necessarily be repaid in money. The borrower can make repayments, wholly or in part, by a bona fide transfer to the lender of real or personal property. A transfer of property constitutes repayment only to the extent of the fair market value of the transferred property at the time of the transfer.

¶ 27. Repayments are considered to apply first to the oldest loan or debt outstanding ("first-in, first-out basis") unless the facts clearly indicate otherwise.

Whether Repayment Is Part of a Series of Loans or Other Transactions and Repayments

¶ 28. It is a question of fact whether or not a repayment of a loan is part of a series of loans or other transactions and repayments. In most cases, when there are only a few loans or other transactions and a few repayments made during a taxation year of a lender, there is no such series. However, when only one loan or other transaction and one repayment occur in each taxation year of a lender, a series of loans or other transactions and repayments may still be in evidence. This could occur, for example, when a repayment is of a temporary nature, such as a loan that is repaid shortly before the end of the year and the same amount, or substantially the same amount is borrowed shortly after the end of the year. Such a repayment of a temporary nature is not considered to decrease the loan balance in applying subsection 15(2) and paragraph 20(1)(j) to a series of loans or other transactions and repayments (see ¶s 34 to 36 below).

¶ 29. Persons affected by subsection 15(2) may have loan accounts, drawings accounts, or other similarly named accounts that contain several charges for loans, payments made to third parties on behalf of the shareholder, advances against future salaries, rents or anticipated dividends or other charges, and one or more repayments. If a shareholder has an account with a number of these features (a running loan account), all of the relevant factors will be considered to determine whether a series of loans or other transactions and repayments exists. Bona fide repayments of shareholder loans that result from, for example, the payment of dividends, salaries, or bonuses, are not part of a series of loans or other transactions and repayments.

Deduction of Repayment if Not Part of a Series

¶ 30. Paragraph 20(1)(j) provides that when a borrower has repaid all or part of a loan that was included in income for a preceding year under subsection 15(2), the amount of the repayment is deductible in calculating income for the year in which the repayment is made. However, no deduction is allowed:

(a) if the borrower was a corporation, to the extent that the amount of the loan was deductible from its income for the purpose of calculating taxable income in the year the loan was made; or

(b) if the repayment is made as a part of a series of loans or other transactions and repayments.

¶ 31. The comments in ¶s 24 to 29 above, on what constitutes a repayment and whether a repayment is part of a series of loans or other transactions and repayments, apply for the purposes of determining the deduction of a repayment as provided for in paragraph 20(1)(j).

¶ 32. As paragraph 20(1)(j) refers to a "taxpayer" and the Act defines a "taxpayer" as including a "person" and a "person" as including a legal representative after death, the deceased taxpayer's estate can claim the deduction under this paragraph in the year a repayment is made. In order to make the claim, the deceased must have included the amount of the loan in income in a preceding taxation year.

¶ 33. Paragraph 20(1)(j) applies to a partnership if a loan subject to subsection 15(2) has been included in calculating the income of the partnership in a preceding year and the partnership subsequently repays the loan.

Application of Subsection 15(2) and Paragraph 20(1)(j) When "a Series"

¶ 34. When there is a series of loans or other transactions and repayments (see ¶s 28 and 29 above), the exception in subsection 15(2.6) does not apply unless bona fide repayments are made. Loans which do not meet this test are included in income pursuant to the opening words of subsection 15(2) without allowing the one year for possible repayment, unless they come within one of the other excepting provisions of subsections 15(2.3) to (2.5).

¶ 35. To determine the amount to be either included under subsection 15(2) or deducted under paragraph 20(1)(j) in calculating the income of a particular taxation year of the borrower, the account must be analyzed. A temporary repayment (see ¶ 28 above) is not considered to be a repayment and will not be recognized as a decrease of the account balance. The foregoing is illustrated by the example in ¶ 36 below.

Example

¶ 36. Mr. Founder is a minority shareholder of Alphaco. Alphaco has a calendar year end. Mr. Founder receives a salary which results in take home pay of $2,500 per month. The following events are reflected in the shareholder's loan account.

At the end of 1992, the company owed Mr. Founder $2,000.

In 1993, Mr. Founder charged $20,000 in miscellaneous amounts to his loan account and $5,000 for a membership in a club. On October 15, 1993, Mr. Founder transferred ownership of 500 shares of Megabank, a company traded on a prescribed stock exchange, to Alphaco. The shares closed at $28 on that date. The minutes of Alphaco's annual meeting approved the purchase of the Megabank shares and the financial statements reported the shares as a property acquired at a cost of $14,000. Mr. Founder advised the transfer agent for the shares of Megabank that he had transferred ownership of the shares to Alphaco.

In 1994, Mr. Founder charged $23,000 in miscellaneous amounts to his loan account. Alphaco declared a bonus of $10,000 to Mr. Founder in the year.

In 1995, Mr. Founder charged $27,000 in miscellaneous amounts to his loan account and $32,000 for an automobile that he purchased when his previous automobile was destroyed in a fire. Among the conditions attached to the loan were that Mr. Founder apply the proceeds of the insurance settlement of his previous automobile to reduce the loan for his new automobile and that the $500 per month for rent that the company pays Mr. Founder be applied to the loan, with the first payment to be made on November 1, 1995. The loan is not exempt under the provisions of paragraph 15(2.4)(d), as described in ¶ 21 above. Mr. Founder endorsed to Alphaco the cheque for $12,000 that he received from his insurance company for the loss of his previous automobile. Alphaco paid a bonus of $10,000 to Mr. Founder in the year.

In 1996, Mr. Founder charged $18,000 in miscellaneous amounts to his loan account and $15,000 for a winter cruise. On December 27, 1996, Mr. Founder made a cash payment of $30,000 to reduce the amount in his shareholder loan account. Alphaco declared and paid a dividend of $10,000 and a bonus of $10,000 to Mr. Founder in the year.

In 1997, Mr. Founder charged $22,000 in miscellaneous amounts to his loan account and on January 6, 1997, he withdrew $30,000 to repay a personal loan. Alphaco declared and paid a dividend of $15,000 and a bonus of $10,000 to Mr. Founder in the year.

Mr. Founder's Shareholder Loan Account

Mr. Founder's Automobile Loan Account

Analysis of Mr. Founder's Shareholder Loan Account

Analysis of Mr. Founder's Automobile Loan Account

Summary of Applications of Subsection 15(2) and
Paragraph 20(1)(j)

Non-Residents

¶ 37. Subsection 15(7) provides that subsection 15(2) applies in calculating the income under Part I of a person or partnership, described in ¶ 2 above, whether or not the lender, described in ¶ 1(a) to (c) above, was resident in Canada or carried on business in Canada. Subsection 15(2.2) provides that subsection 15(2) does not apply to indebtedness between non-resident persons.

¶ 38. If the borrower is a non-resident, paragraph 214(3)(a) deems, for purposes of Part XIII, amounts which would be included in income under subsection 15(2), if Part I were applicable, to have been paid to the non-resident as a dividend from a corporation resident in Canada (unless the lender is also a non-resident). A dividend paid by a corporation resident in Canada to a non-resident is subject to an income tax under subsection 212(2). Subsection 215(1) requires the lender to withhold and remit the income tax to the Receiver General. If there is no series of loans or other transactions and repayments (see ¶ 28 above), the non-resident who has received a loan in a particular taxation year cannot be deemed to have received a dividend until one year after the end of the taxation year of the lender, in order to determine if the exception under subsection 15(2.6) applies. Consequently, it is the Department's practice, in these circumstances, not to levy a penalty and not to charge interest in respect of the requirement for remittance of the tax, provided that the tax is remitted on or before the 15th day of the 13th month following the end of the taxation year of the lender in which the loan was made (if the tax is not remitted by this day, interest will start accruing as of the 16th day of the 13th month). If there is a series of loans or other transactions and repayments (see ¶s 34 to 36 above), the tax is based on the net increase of the loan during the taxation year of the lender. In the case of a series, a penalty will not be levied and interest will not be charged provided that the tax is remitted on or before the 15th day of the month following the end of the lender's taxation year in which the net increase occurred. (If the tax is not remitted by this day, interest will start accruing as of the 16th day of the month following the end of the lender's taxation year.)

¶ 39. Subsection 227(6.1) provides for a refund of the Part XIII tax paid on a loan deemed to be a dividend by virtue of paragraph 214(3)(a) if the person, on whose behalf the tax was paid, repays the loan after December 21, 1992, and the repayment is not part of a series of loans or other transactions and repayments. The refund is limited to the lesser of the Part XIII tax originally paid on the portion of the loan being repaid, and the Part XIII tax that would be payable if, at the time of the repayment, a dividend described in paragraph 212(2)(a), equal to the amount of the repayment, were paid to the person. In order to obtain the refund, application must be made within 2 years of the end of the calendar year in which the repayment is made. However, when the person is or is about to become liable to make any payment to Her Majesty in right of Canada, the amount of the refund may be applied to that payment.

¶ 40. The comments in 27 above apply for the purposes of determining the Part XIII tax refund as provided in subsection 227(6.1). Unless the facts clearly indicate otherwise, repayments are considered to apply first to the oldest loan or debt outstanding.

¶ 41. Because paragraph 214(3)(a) applies only for purposes of Part XIII, if the lender is a private corporation the deemed dividend does not qualify as a dividend paid by the corporation for purposes of subparagraph 129(1)(a)(i) (dividend refund).

Explanation of Changes

Introduction

The purpose of the Explanation of Changes is to give the reasons for the revisions to an interpretation bulletin. It outlines revisions that we have made as a result of changes to the law, as well as changes reflecting new or revised departmental interpretations.

Reasons for the Revision

We have revised the bulletin to reflect

• changes to the Income Tax Act resulting from S.C. 1987, c.46 (formerly Bill C-64), S.C. 1991, c.49 (formerly Bill C-18), S.C. 1994, c.21 (formerly Bill C-27), and S.C. 1998 c.19 (formerly Bill C-28),
• new and revised departmental positions including a change in the departmental assessing practice to apply payments to generally the oldest outstanding amount in a shareholder loan account, and
• relevant court decisions, including Joel Attis v. MNR, 92 DTC 1128, [1992] 1 CTC 2244, Uphill Holdings Ltd. and Nigel T. Hill v. MNR, 93 DTC 148, [1993] 1 CTC 2021 which discuss bona fide repayments of shareholders' loan accounts that are not part of a series of loans and repayments.

Bill C-28, except as otherwise noted, applies to loans made and indebtedness arising in the 1990 and subsequent taxation years. Bill C-28 reorganized subsection 15(2) but, except for the addition of paragraph 15(2.4)(e), the law is not significantly changed. The comments in the bulletin are not affected by any proposed legislation that was released before June 19, 1998.

Legislative and Other Changes

Bill C-28 reorganized subsection 15(2) and moved the exceptions contained in former paragraphs 15(2)(a) and (b) to subsections 15(2.3), (2.4), and (2.6). As part of the reorganization, subsection 15(8) was repealed; however, the provisions of that subsection are contained in subsection 15(2.2). A paragraph in the bulletin is not noted as being changed when the only change is as a consequence of the reorganization.

Former ¶ 1 has been incorporated into the Summary.

¶ 4 (former ¶ 5) has been revised to add an example to illustrate the effect of the phrase "a taxation year" in subsection 15(2).

¶ 6 was added to describe subsection 15(1.2). This subsection, applicable to obligations settled or extinguished after February 17, 1987, determines the value of the benefit to be included in a shareholder's income, when a loan or other obligation of the shareholder to a corporation is settled or extinguished by payment of less than the amount of the obligation outstanding, or by no payment.

¶ 7 is a restructuring of part of former ¶ 12 and notes that a loan or indebtedness will not have to be included in income under subsection 15(2) if the loan or indebtedness falls within the provisions of one of subsections 15(2.2) to (2.6).

New ¶ 8 describes subsection 15(2.3). The subsection is a restatement of former subparagraph 15(2)(a)(i).

New ¶ 9 describes subsection 15(2.4). Paragraph 15(2.4)(a) provides an exception for loans to or indebtedness of an employee who is not a specified employee of the lender. Paragraphs 15(2.4)(b) and (c) are restatements of former subparagraphs 15(2)(a)(ii) and (iii) while paragraph 15(2.4)(d) is fundamentally a restatement of former subparagraph 15(2)(a)(iv). The exceptions in paragraphs 15(2.4)(a) to (d) apply when the provisions of paragraphs 15(2.4)(e) and (f) are satisfied. Paragraph 15(2.4)(e), which applies after April 25, 1995, provides that the loan or indebtedness must be received or incurred because of the employee's employment rather than because of employee's shareholding. Paragraph 15(2.4)(f) restates the requirement in the former subsection 15(2) concerning the arrangements for repayment of the loan or indebtedness. For the purposes of the application of new paragraph 15(2.4)(e), a loan will be considered to have been made after April 25, 1995, if the funds are advanced to the borrower after that date.

New ¶ 10 describes subsection 15(2.5). The subsection applies to certain loans made by a private corporation to a trust. The trust essentially acts as a willing buyer or seller of the shares of the corporation for its employees.

New ¶ 11 discusses the situation where a corporation makes a loan to an individual who is both an employee and a shareholder and describes the most important factors that will be considered in determining whether the loan will be seen as having been made to the individual as an employee or as a shareholder.

¶ 13 (former ¶ 14) reflects amendments to the former subparagraphs 15(2)(a)(ii) and (iii) (amended paragraphs 15(2.4)(b) and (c)) regarding the borrower to whom the subparagraphs applied. The amendment to former subparagraph 15(2)(a)(ii) applied to the 1985 and later taxation years while the amendment to former subparagraph 15(2)(a)(iii) applied to loans arising after 1981.

New ¶ 16 describes the application of subsection 15(2.3) where an individual has revolving debt with a financial institution and owns shares in the institution or is connected with someone who owns shares in it.

¶ 17 (former ¶ 16) reflects an amendment to former subparagraph 15(2)(a)(ii) (amended paragraph 15(2.4)(b)). As a result of this amendment, a share of the capital stock of a cooperative housing corporation could qualify for the exception. In addition, the amendment clarified that the dwelling must be acquired for habitation by "the individual" (the employee or the employee's spouse) who incurred the loan. The amendment to former subparagraph 15(2)(a)(ii) applied to the 1985 and later taxation years. ¶ 17 also notes the addition of subsection 252(4) which, after 1992, expands the definition of "spouse."

¶ 18 (former ¶ 17) has been revised to add an example of how a loan to an employee to purchase a house might be refinanced with a loan, which would qualify under paragraph 15(2.4)(b), from the employee's employer.

¶ 20 (former ¶ 19) reflects an amendment to former subparagraph 15(2)(a)(iii) (amended paragraph 15(2.4)(c)). The exception in the provision was amended to apply to loans made by a corporation to an employee of a related corporation. In addition, the amendment clarified that the shares which qualified for the exception must be previously unissued shares. The amendment to former subparagraph 15(2)(a)(iii) applied to loans arising after 1981.

New ¶ 21 describes paragraph 15(2.4)(d), an exception concerning the acquisition of a motor vehicle by an employee for use by the employee in the performance of his or her duties of employment.

New ¶s 22 and 23 discuss the meaning of the term "specified employee" in connection with a corporation and a partnership.

¶ 27 (former ¶ 24) has been revised to delete the comments concerning the netting of loans and repayments since that practice is generally inconsistent with applying payments to the oldest outstanding indebtedness.

¶ 29 (former ¶ 26) has been revised to note that pursuant to court cases, such as Joel Attis v. MNR and Uphill Holdings Ltd. and Nigel T. Hill v. MNR, bona fide repayments of shareholder loans which are the result of, for example, the payment of dividends or bonuses are not considered part of a series of loans or other transactions and repayments.

¶ 30 (former ¶ 27) has been revised to delete the last sentence in the paragraph since the sentence is inconsistent with paragraph 20(1)(j).

¶ 34 (former ¶ 31) has been revised to describe that a bona fide repayment applies to a series of loans or other transactions and repayments. The last two sentences have been deleted as they are inconsistent with paragraph 20(1)(j).

¶ 35 (former ¶ 32) has been revised to delete the comments concerning the analysis of the net increase or net decrease to determine the taxation year in which it arose. This analysis should not be necessary since pursuant to Paul Quigley v. Her Majesty the Queen, 96 DTC 1057, [1996] 1 CTC 2378, payments are generally applied to the oldest outstanding amount.

¶ 36 (former ¶ 33) has been expanded to reflect relevant court decisions such as Joel Attis v. MNR, Uphill Holdings Ltd. and Nigel T. Hill v. MNR and Paul Quigley v. Her Majesty the Queen which support applying payments generally against the oldest outstanding amount.

¶ 37 combines the discussion in the former ¶s 7 and 8.

¶ 38 (former ¶ 9) clarifies that not only the penalties, but also the interest, will not be charged until the dates indicated in that paragraph.

¶ 39 replaces former ¶ 10 and describes subsection 227(6.1). The subsection, which applies to repayments made after December 21, 1992, provides for a refund of the Part XIII tax paid on a loan deemed to be a dividend under paragraph 214(3)(a), when the loan is repaid and certain other requirements are met.

New ¶ 40 notes that in applying subsection 227(6.1), repayments are considered to apply first to the oldest loan or debt outstanding, unless the facts clearly indicate otherwise.

Throughout the bulletin, we have made minor changes for clarification or readability purposes.

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