I am reviewing the tax implication of a loan to a shareholder employee from the corporation. The shareholder borrowed loan from the corporation for home renovations. Does renovations fall under new home purchase? The shareholder did not purchase a new home. He is renovating his existing home. Anyone know of case law or is there a broad definition of home to include renovations?
15(2.4) (b) in respect of an individual who is an employee of the lender or creditor or who is the spouse or common-law partner of an employee of the lender or creditor to enable or assist the individual to acquire a dwelling or 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, where the dwelling is for the individual’s habitation,
I don’t think a renovation would qualify. The answer might be different if the renovation were to occur almost immediately after buying the property and the argument could be put forward that the renovation was part of the acquisition.
I assume you’re aware of the potential issues with these loans, foremost of which is whether the client got this loan in their capacity as an employee as opposed to a shareholder.
That question came up a lot from small business owner, my question is usually, if you have enough money in the company, but not paying yourself enough to sustain your personal living, how are you going to justify that question when being questioned from CRA. If the purpose is to save taxes, then the purpose becomes tax avoidance
The purpose of these loans, from my experience, is to pay personal tax on the loan amount over, say 15 years, as opposed to all in the one year. The shareholder does end up paying tax on the amount withdrawn (with interest); just at hopefully a lower average rate. Assuming the rules are followed, it’s not a tax avoidance issue to follow provisions included in the Act.
It’s a question of fact situation, and not up to us as accountant to determine, but factoring in both situations, the owner has significant cash from profit, taxed at the lower rate, you need the cash, let say, even to buy a principal resident, there is definitely a benefit there, GAAR could apply, because you are not deferring the taxes, you are using the money inside the company for personally purpose. Not just simply leaving the cash inside the corporate and take it out over the year to minimize taxes.
Sure, there is a benefit with a housing loan, which is taxed each year (interest and principal). I’m not commenting on this particular situation since I don’t have the information to make that call. But if the rules of 15(2.4) are followed, I’m doubtful CRA could successfully raise GAAR as an issue. If CRA could raise GAAR as an issue here, what stops them from making a GAAR assessment with a company-owned vehicle used personally, even though the company issues a taxable benefit to the shareholder each year?
In my experience, a shareholder has never received a loan in his capacity as an employee. Ask the client, would the same offer be made to any employee? Answer is very likely a resounding “No”. You can’t just see the word “employee” and assume the shareholder can squeeze in. When there’s a shareholder loan, make sure interest is charged and paid at the prescribed rate and that the loan is fully repaid by the end of the following fiscal year. That will mean taking a bonus or dividend over 2 years.
I’m sure we all have corporate clients with huge debit balances owed by shareholders. I use the correct GIFI code each year to show it as “due from individual shareholder(s)” and warn my client of the double-taxation consequences if CRA ever bothers to pick it up. Advice is routinely ignored. I don’t know why CRA have never cracked down on this. All they have to do is produce a list of all T2’s with amounts reported under GIFI code 1301.
I agree with you, @jhd.hemeon. I haven’t seen anyone who can meet the test. But if the test can be passed and the documentation drawn correctly, the loan would be legitimate.
In a bona fide situation, not being specific to this question, what benefit do you see from the loan with the same rate where the owner can get personally?
The company pays tax on the interest income, the owner can not use the interest as deduction
In a situation where the owner can get a loan outside the company at the same terms, I don’t see much benefit. Also, financing outside the company avoids a 15 year potential CRA issue.
The interest rate on a shareholder loan like this is normally less than market rates. The current (Q1 2023) rate is 4% but back in Q4 2021 the rate was 1% per year, locked in for the first 5 years. The current 5 year fixed rate is probably 5.5 to 6% per year.
The company shouldn’t have to pay tax on the loan interest. The company issues a T4 to the employee for a taxable benefit on the interest. The company doesn’t show it as income (and is not deducting the interest benefit charged to the employee).
When I have clients talk to me about this, I explain the “capacity” issue and tell them that I’m documenting our conversation. Most are interested but realize there’s no free money coming from the company and back off.
That’s very common, I also, tell clients that they have to use dated resolution for that purpose to prove the payment is deemed to be made before the deadline, etc…
I actually haven’t look into, now that we are discussing this topic, the interest income from the corporation, would that be considered as passive interest income? And that will cause Par IV tax, and the SBC grind
Thank you for the responses, very insightful!
I have - though it was two decades ago.
The question is always “Was the loan made qua employee or qua shareholder”?
In most cases…it’s qua shareholder and it fails on the employee test. However, some companies have policies - Board granted and long-standing - in their Minute Books granting employees loans for car or home purchases, generally based on longevity with the organization. As long as the employees can - and do - qualify and the corporation can show that they are willing to provide funds to an 'ee (and or have done so), the shareholder-'ee should also qualify.
But. It’s very rare that corporations pass such Resolutions and in fact act on them appropriately.