31 August 2010 External T.I. 2010-0368641E5 - Loan - Bonus payment

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 tax treatment of the amount received as a 'bonus' in a loan agreement?

Position: The receipt could be regular income, interest or a capital gain, depending on the facts of the situation.

Reasons: It is a question of fact.

XXXXXXXXXX
									2010-036864
									V. Srikanth
August 31, 2010

Dear XXXXXXXXXX :

Re: Bonus received in relation to a loan

This is in response to your correspondence dated May 25, 2010, wherein you requested our views regarding the tax treatment of the amount received as a 'bonus' as part of a loan agreement. Specifically, you described a scenario where a loan agreement includes an amount referred to as a 'bonus'. The 'bonus' is due and payable by the borrower at the end of the term of the loan irrespective of when the principal amount of the loan is repaid. You want our views on the tax treatment of the bonus amount in the hands of the recipient, i.e., the lender.

Our Comments

This appears to be an actual situation. It should be noted that written confirmation of the tax implications inherent in actual proposed transactions is given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, entitled Advance Income Tax Rulings dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on our website at http://www.cra-arc.gc.ca. If, however, the particular transactions are completed or partially completed, the enquiry should be addressed to the relevant Tax Services Office ("TSO"). A list of TSOs is available on the "Contact Us" page of the CRA website. Your request was not submitted as an advance income tax ruling request, however, as stated in paragraph 22 of IC 70-6R5, we do provide written opinions on general enquiries and we are prepared to provide you with the following comments.

Whether an amount received as a bonus in relation to a loan is taxable as regular income, interest or a capital gain is a question of fact. It depends on factors such as the legal documents, the business nature of the lender, the intent of the parties to the loan arrangement, etc. However, your situation appears to be very similar to the situation described in the Federal Court case of Western Union Insurance Company v The Queen 83 DTC 5388, wherein the central issue raised, inter alia, was whether a bonus in the amount of $325,000 earned by the Western Union Insurance Company (the plaintiff), on a loan of $1,125,000 it made to WWW Developments Ltd, was income of the plaintiff or whether the bonus ought to be considered as a capital gain. In concluding that the bonus amount was regular income and not a capital gain, Dubé, J. made the following comments:

"In my view, the plaintiff in the instant appeal carried out the functions of conventional lending institutions and did so much in the same fashion as moneylenders do. The fact that this was only its second loan is not the determinant factor. It made a gainful use of its monetary assets, thus raising a presumption that it was carrying on a business. It earned a bonus because it agreed to advance money to the borrower and it did so in the course of its own established business. It did precisely what an ordinary moneylender would do except, perhaps, that it charged more."

Further, the Exchequer Court of Canada case, West Coast Parts Co. Ltd. v MNR 64 DTC 5316, involved a situation where the appellant company, formerly selling truck parts, loaned $125,000 to a group of contracting companies. The loan was repayable in two instalments in less than two years with 10% interest and with a bonus of $56,000. In concluding that the bonus was taxable as profit arising from an adventure in the nature of trade, the following comments were made by Cattanach, J.:

"When a person enters into a contract whereby he advances money to another person on terms that it is to be repaid at a fixed time together with an additional amount, if that additional amount is described as interest, there is no problem. Interest is income from property within Section 3 of the Income Tax Act and it is specifically required to be included in computing income.... When such a contract requires repayment with such an additional amount, but does not describe it as interest, it becomes a question of fact as to whether the additional payment is or is not in fact interest or, in any event, a profit from property in the sense of revenue derived from the money advanced. If the additional payment is the sole consideration for use of the money, there would appear to be a very strong probability that it is interest or a payment in lieu of interest. The problem is more complicated where, as here, the contract provides for repayment with interest as such plus an additional fixed amount. Usually the promise of such an amount is not regarded as being a payment for the use of the money, but as an inducement to the lender to incur the risk of not getting his money back in speculative circumstances. I cannot escape the conclusion that, in such event, the lump sum payment, not being payment merely for the use of the money, is, in the absence of very special circumstances, a profit from an adventure in the nature of trade."

We trust our comments will be of assistance to you.

Yours truly,

R.A. Albert, CA
For Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch