24.10.0 Benefits conferred on shareholders 24.10.1 ... · Here are some examples of benefits: ......

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24.0 Transactions involving related persons, corporations and shareholders, dividends, etc.

(Revised March 2015)

24.10.0 Benefits conferred on shareholders

(Revised December 2013)

24.10.1 Introduction


Shareholders may be in a position to profit from their relationship with a corporation by

receiving personal advantages in the form of "benefits" from the corporation. The Income Tax

Act (ITA) does not define a "benefit" conferred on a shareholder. In Vine et al. v. the Queen,

1989 (FCTD) 89 DTC 5528, the definition used was a "benefit refers to monetary amounts

received from the corporation by the shareholder and not the shareholder's overall financial or

physical well-being."

Here are some examples of benefits:

• a payment to a shareholder by a corporation other than under a bona fide business

transaction

• the payment of the shareholder's personal expenses by the corporation

• the sale of goods by a shareholder to a corporation for an amount greater than the fair

market value (FMV)

• the sale of goods by a corporation to a shareholder for an amount less than FMV

• an addition or improvement to a shareholder's property paid by the corporation

• the personal use of the corporation's property (for example, house, car, yacht) without a

FMV charge or return

• the theft or embezzlement of funds by a shareholder

• training costs reimbursed to the shareholder

• private health-care plans

• shareholder’s life insurance premiums paid by the corporation

• a guarantee provided by the corporation in respect of the shareholder's personal loans

Under subsection 15(1) of the ITA, the amount or value of a benefit conferred on a shareholder,

or on a person in contemplation of becoming a shareholder, by a corporation in a taxation year is

included in the shareholder's income for the year, except if the benefit is deemed by section 84

to be a dividend. The auditor must:

• determine whether the shareholder received a benefit, then

• determine whether one of the exceptions in paragraphs 15(1)(a) to (d) applies and, if not,

• determine its value for income tax purposes.

Read this subchapter together with Income Tax Interpretation Bulletin IT432R2, Benefits

conferred on shareholders, at www.cra-arc.gc.ca/E/pub/tp/it432r2/README.html.

24.10.2 Income tax implications

http://www.cra-arc.gc.ca/E/pub/tp/it432r2/README.html

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General comments

Subsection 15(1) of the ITA generally applies when a corporation confers a benefit on a

shareholder. The value of the benefit, other than that set out in the exceptions, must be included

in computing the shareholder's income in the year the shareholder received the benefit or had the

right to the property that constituted the benefit except to the extent that the benefit is deemed by

section 84 to be a dividend. The benefit is to be assessed as income from property.

Subsection 15(1) prevents benefits from flowing to shareholders without the appropriate

payment of tax. The benefits are not deductible by the corporation and are similar to dividends.

Subsection 15(7) confirms that subsection 15(1) applies to a resident shareholder of a non-

resident corporation whether or not the corporation was resident in Canada or carried on business

in Canada.

Meaning of "confer"

For subsection 15(1) to apply, a benefit must have been "conferred" on a "shareholder." It does

not apply if the benefit was conferred on a taxpayer in the capacity as a customer, vendor, or

employee of the corporation.

"Confer" means to grant or to bestow. For the benefit to be included in the shareholder's income

under subsection 15(1), the shareholder must have been aware that the benefit had been

conferred or the corporation must have intended to confer the benefit. Determining whether the

corporation had intended to confer a benefit on the shareholder is a question of fact.

This means if a shareholder is not aware of the benefit, subsection 15(1) cannot apply. For

example, in The Queen v. Chopp, 1998 (FCA) 98 DTC 6014, the Federal Court of Appeal (FCA)

refused to overturn the lower court's finding of fact that the circumstances surrounding the

transaction indicated an innocent accounting error that should not lead to taxation. However, the

court agreed that, in interpreting the ITA, a benefit can be conferred on a shareholder without the

corporation or the shareholder intending to do so, or being aware of the fact, if these two

conditions are met:

1. The circumstances are such that the corporation or shareholder "ought to have known"

that a benefit was conferred.

2. The corporation or shareholder did nothing to rectify the conferring of the benefit.

While the burden of proof is on the taxpayer to prove that a reassessment is incorrect, only when

the facts clearly indicate the parties in question knew or "ought to have known" that a benefit had

been conferred, should the income be reassessed under subsection 15(1). To determine whether

one of the parties "ought to have known" that a benefit had been conferred, consider the size of

the benefit in relation to the corporation's revenues, expenses, or shareholder loan account.

The Franklin case

Include a review of the Franklin decision to determine whether a benefit is considered to have

been conferred on a shareholder.

Facts of Franklin

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1. The taxpayer was a shareholder of the corporation Homeguard Video Systems Ltd.

(HVSL). HVSL purchased a condominium unit (the "Unit").

2. All monies required by HVSL to acquire the Unit were advanced to the corporation by

the taxpayer out of his personal resources (including a personal line of credit). The

advances were reflected in the corporation's financial statements as a credit to the

shareholder loan account.

3. Shortly after acquiring the Unit, HVSL sold an undivided 50% interest therein to an arm's

length third party for approximately $59,000.

4. Of this amount, approximately $21,399 was deposited to the taxpayer's personal bank

account and $22,400 was used to pay off his personal line of credit.

5. The sale was not recorded in the financial statements of HVSL, nor was the shareholder

loan account reduced to reflect the receipt of funds by the taxpayer. The shareholder loan

account at that time had a credit balance of approximately $154,000.

6. The taxpayer was assessed a subsection 15(1) benefit for the proceeds he received from

the sale.

Franklin et al. v. The Queen, 2000 (TCC), 2000 DTC 2455

The Tax Court concluded that even though the taxpayer had deliberately failed to report the

transaction, no benefit had been conferred on the taxpayer as contemplated by subsection 15(1).

The basis for the Court's decision was that a series of bookkeeping errors occurred, which were

caused by the taxpayer either on purpose or inadvertently, none of which gave the taxpayer any

identified benefit. The Court also found that the taxpayer had not withdrawn any money from the

corporation in excess of the credit balance in his shareholder loan account, nor was there any

evidence that the taxpayer used the incorrect financial statements to obtain a benefit elsewhere

for himself.

The Queen v. Franklin, 2002 FCA 38

The decision at the Federal Court of Appeal (FCA) was split. The majority agreed with the Tax

Court's finding that there was no benefit conferred on the taxpayer according to subsection

15(1). The FCA agreed with the Tax Court's assessment of facts. However, the judge went on to

say: "…this judgment is not to be interpreted as condoning taxpayers negligently keeping

inaccurate records or deliberately not disclosing transactions."

Go to 24.10.4 section, Application of subsection 15(1) – Credit balance in the shareholder loan

account, which discusses the Canada Revenue Agency (CRA)'s guidelines for reassessing

shareholder benefits under subsection 15(1) as a result of the Franklin decision.

Shareholder or person "in contemplation" of becoming a shareholder

A benefit may be included under subsection 15(1) if the person was not a shareholder, but was

intending to become a shareholder. The expression "in contemplation" means to be in a position

to, to be on the point of. This expression is aimed at preventing a person from avoiding

subsection 15(1) by simply choosing the right moment to become a shareholder. As long as the

person had the intent of becoming a shareholder, subsection 15(1) may apply.

Exceptions to the application of subsection 15(1) of the ITA

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If a transaction involving a corporation and a shareholder is a bona fide business transaction,

there is no benefit to the shareholder under subsection 15(1). Normally, a transaction is

considered to be bona fide when the terms and conditions are essentially the same as they would

be if parties dealing at arm's length entered into the transaction.

A shareholder benefit cannot be included in income under subsection 15(1) if it falls within any

of the exceptions described in paragraphs 15(1)(a) to (d). For more information, go to paragraph

two of Income Tax Interpretation Bulletin IT432R2, Benefits conferred on shareholders, at

www.cra-arc.gc.ca/E/pub/tp/it432r2/README.html.

Benefits - Non-resident shareholders

The tax treatment of a benefit conferred on a non-resident shareholder who is also an employee

depends on whether the person received the benefit in their capacity as a shareholder or an

employee.

When the non-resident shareholder receives an amount or a benefit in the shareholder's capacity

as an employee, subsection 2(3) applies. When the non-resident shareholder receives an amount

or a benefit in the role of a shareholder, paragraph 214(3)(a) deems such an amount to be a

dividend to which the normal non-resident tax rules under Part XIII apply. In this case, the

auditor must confirm with the Non-Resident Section that the applicable procedure has been

followed.

Determining the amount or value of the benefit

The taxable value of the benefit calculated for the purposes of subsection 15(1) can be

determined in two ways:

1. based on the expenses and the purchase price of a property that the corporation did not

use to produce income from a business or property;

2. based on the FMV of the property or benefit conferred on the shareholder.

For 1996 and subsequent taxation years, if the cost of purchasing or leasing a property or service

is used to determine the amount of the benefit under subsection 15(1), that cost shall include any

tax payable (for example, goods and services tax/harmonized sales tax (GST/HST), provincial

sales tax (PST), luxury tax) on the property or service. Before 1996, the GST/HST was

calculated separately.

Forgiveness of shareholder debt

Subsection 15(1.2) says that the subsection 15(1) amount from the settlement or extinguishment

of a loan or other obligation issued by a debtor is the "forgiven amount," as defined in subsection

15(1.21). The "forgiven amount" is the amount of the outstanding obligation that was settled,

less the amount paid by the shareholder on the settlement of the obligation, and less the amount

included in the shareholder's income at the time the obligation arose.

If a forgiven amount is included as a benefit under subsection 15(1), the rules on debt

forgiveness under section 80 do not apply to the debt's principal.

24.10.3 For future use

24.10.4 Audit issues



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Interrelationship of subsection 15(1) and paragraph 6(1)(a) of the ITA

If a benefit is conferred on a shareholder who is also an officer or an employee of the

corporation, it is necessary to determine the facts of whether the benefit was received by the

taxpayer in the role of a shareholder or an employee. If it was received as a shareholder,

subsection 15(1) applies and subsection 18(1) does not allow a deduction to the corporation. If it

was received as an employee, paragraph 6(1)(a) applies. In this case, the amount of the benefit is

allowed as a deduction to the corporation providing that the amount is reasonable.

If a corporation continues charging payments on behalf of a shareholder-employee to its expense

accounts after having been advised that it is improper, such action will indicate that the benefits

were received in that person's capacity as a shareholder. The benefits will be taxable under

subsection 15(1).

Benefits unrelated to the corporation's normal activities

Subsection 15(1) will also apply to payments, appropriations, benefits, or advantages for the

shareholder, which are not related to the normal operations of the business. These could include

the purchase of clothing and other personal items for the shareholder and family and the

forgiveness of a debt owing by the shareholder to the corporation.

Benefits related to the corporation's business activities

Benefits made to a shareholder who is also an officer or employee, which relate to the business

activities of the corporation or can reasonably be viewed as additional salary, will be taxed under

paragraph 6(1)(a).These expenses could include such items as promotion and entertainment

outlays and the payment of the expenses of the shareholder-employee's spouse or common-law

partner at a business convention.

Refer to Income Tax Interpretation Bulletins:

• IT131R2, Convention expenses, at www.cra-arc.gc.ca/E/pub/tp/it131r2/README.html

• IT470R-CONSOLD, Employees' fringe benefits, at www.cra-arc.gc.ca/E/pub/tp/it470r-

consolid/README.html

If an amount is treated by a corporation as wages to a shareholder-employee, regardless of the

actual payee of the amount, the CRA will consider it to be wages to that employee. Therefore, if

an amount is paid to a third party on behalf of the shareholder-employee, and the corporation

treats the amount as wages, the CRA will not assess a subsection 15(1) benefit for that amount.

However, withholdings must be made and the amount must be included on the individual’s T4

slip.

In what capacity did the shareholder-employee receive a benefit?

The auditor needs to determine if the shareholder received the benefit as a shareholder or as an

employee. Consider these factors:

• Did the corporation offer the benefit to all employees or to one category of employees

(for example, based on number of years with the company, management vs.

non-management functions)?

• Did the corporation offer the benefit to shareholders only?

• What level of control do the held shares represent?


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• How do the benefits compare with the employee's remuneration and shares held?

• What was the nature of the benefit?

• What is the importance for the corporation of the services the beneficiaries provided in

their role as employees?

Go to Bernstein v. MNR, 77 DTC 5187 (FCA) for the factors to consider.

Doubtful cases

If there is a genuine doubt as to the capacity in which a shareholder-employee received a benefit,

the amount may be taxed under paragraph 6(1)(a). Some of the factors that would justify this

treatment include:

• The taxpayer has a reasonable explanation for charging the business with personal

expenses.

• The adjustment is of an isolated nature and there is no audit evidence of other abuses by

the shareholder.

• There is no reason to believe that the shareholder has made a practice of writing off

personal expenses to the business.

• There is nothing to indicate that a deliberate attempt was made to avoid the payment of

tax.

• The amount is not material.

Document review

Review these documents:

• employment contracts

• shareholder agreements

• minutes of board of director meetings

• guidelines setting out the corporation's policy

• corporate minute books

Corporate deduction – Voluntary disclosures

As a rule, no deduction will be allowed to the corporation in respect of an amount included in the

income of a shareholder under subsection 15(1).

However, when the corporation is controlled by persons with whom the current owners deal at

arm’s length, the corporation is permitted to deduct the amount of the benefit or appropriation

when these criteria are met:

• The benefit was conferred upon or appropriated by a former shareholder or employee.

• The current owners or shareholders:

• dealt at arm's length with the former owners or shareholders from whom they

acquired the corporation;

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• acquired the corporation in good faith and without knowledge of the benefits

conferred or appropriations taken; and

• made a full and complete voluntary disclosure according to Income Tax

Information Circular IC00-1R3, Voluntary Disclosures Program, at www.cra-

arc.gc.ca/E/pub/tp/ic00-1r3/README.html

Reimbursement policy

The general rule is that a reimbursement by a shareholder of an amount taxable under subsection

15(1) will not be allowed as a deduction to the shareholder.

It is the CRA's policy that the shareholder should be offered the opportunity to reimburse the

corporation for the amount that would otherwise be assessable under subsection 15(1) if:

• the corporation makes a leasehold improvement to property owned by the shareholder

and the applicable benefit is determined by means of a valuation;

• the corporation sells property to a shareholder and the amount of the benefit is related

entirely to a question of value;

• a valuation of a lease or lease payment;

• a voluntary disclosure is made in accordance with Income Tax Information Circular

IC00-1R3, Voluntary Disclosures Program, at www.cra-arc.gc.ca/E/pub/tp/ic00-

1r3/README.html.

In these cases, the shareholder must make repayment without delay by a payment to the

corporation or an offset against a liability of the corporation to the shareholder. If this liability is

less than the subsection 15(1) amount, the difference must be made up by cash or its equivalent.

If this is allowed, it is assumed that the corporation acted as the shareholder's agent in paying the

amount in question. If the adjustment of the loan account results in a debit balance at the

transaction or subsequent date, apply subsection 15(2) or subsection 80.4(2), as appropriate. The

policy can still be applied if the shareholder does not have the cash and makes other

arrangements to repay.

The taxpayer should be informed when the repayment can be allowed as a deduction.

If a reimbursement is approved, both the shareholder and the corporation must agree in writing to

this arrangement and to the completion of all appropriate entries in the records of the company.

A copy of this written agreement must be submitted to the CRA.

Whatever decision is reached, include a full explanation of the decision in the Audit Report.

Price adjustment clauses

If property is transferred in a non-arm’s length transaction, the parties sometimes include a price

adjustment clause in the agreement stating that if the CRA determines that the FMV of the

property is different than the price determined in the agreement, that price will be adjusted to

take into account the excess or shortfall. The CRA will recognize that agreement in computing

the income of all parties, provided that all of these conditions are met:

a. The agreement reflects a bona fide intention of the parties to transfer the property at

FMV. When the difference between the FMV is significant, it may indicate that the

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taxpayers did not make a real effort to determine the FMV of the property. What

constitutes a significant difference must be determined on a case–by–case basis.

b. The FMV for the purposes of the price adjustment clause must be determined by a fair

and reasonable method. The taxpayer’s reliance on a different valuation method than the

one chosen by the CRA and the relative inaccuracy of a FMV determination performed in

good faith will not, in and of itself, compromise the effectiveness of the price adjustment

clause. The determination does not have to be completed by a valuation expert. The issue

as to whether or not the parties have used a fair and reasonable method to determine the

FMV of a property is a question that must be resolved in light of a complete examination

of all the relevant facts. It is not sufficient to rely upon a generally accepted valuation

method. It is also necessary that the valuation method be properly applied having regard

to all the circumstances.

c. The parties agree that if the FMV determined by the CRA differs from their valuation,

they will use the value determined by the CRA.

d. The excess or shortfall in price is actually refunded or paid, or a legal liability therefor is

adjusted.

If all of these conditions are met, the CRA will not apply subsection 15(1) to tax a benefit to

shareholders. When the facts in a case indicate that the parties never intended to complete the

transaction at FMV, the price the parties agreed to will not be adjusted and the benefit will be

taxable even if the agreement contains a price adjustment clause. In Guilder News Company

(1963) Ltd. et al. v. MNR (73 DTC 5048) and Elias et al. v. The Queen (97 DTC 1188), the

courts recognized the fact that a reasonable effort had not been made to establish FMVs.

In recognizing the price adjustment clause, appropriate adjustments in computing the income of

all parties to the agreement will be made in their taxation years in which the property was

transferred. If the purchaser has filed returns and claimed capital cost allowances, deductions

from income based on cumulative eligible capital, or exploration and development expenses in

respect of the property for taxation years subsequent to that in which it was transferred, any

necessary adjustments will be made in those subsequent years. Likewise, any reserves claimed

by the vendor to defer the reporting of income will be adjusted.

For more information, go to Income Tax Folio S4-F3-C1, Price adjustment clauses, at www.cra-

arc.gc.ca/tx/tchncl/ncmtx/fls/s4/f3/s4-f3-c1-eng.html. Business Equity Valuation and Real Estate

Appraisal are available to discuss whether a reasonable effort has been made and whether the

approach taken is fair and reasonable. Referrals can be made to the appropriate section.

Application of subsection 15(1) of the ITA – Credit balance in the shareholder loan account

CRA audit policy prior to Franklin

Prior to the Franklin decision (for more details about the Franklin case, go to 24.10.2 section,

Meaning of "confer"), it was the CRA's position to apply subsection 15(1) if a corporation paid

for a shareholder's personal expenditures or when a shareholder appropriated corporate funds.

This was done even if the shareholder loan account was in a credit balance, if the benefit was

conferred with the knowledge or consent of the shareholder, or if it was reasonable to conclude

that the shareholder ought to have known about the benefit.

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Also prior to Franklin, it was possible to offset the shareholder benefit when a reimbursement

was made by the shareholder or a credit was posted to the shareholder loan account in error. As

indicated in the section, Reimbursement policy, a reimbursement by a shareholder of an amount

taxable under subsection 15(1) will not be allowed as a deduction except if:

• the corporation makes a leasehold improvement to property owned by the

shareholder;

• a valuation is involved;

• a voluntary disclosure has been made.

In such cases, the shareholder may make a payment to the corporation or is allowed an offset

against a liability of the corporation to the shareholder. If a reimbursement is requested and

granted, both the shareholder and the corporation must agree in writing to this arrangement and

to the completion of all appropriate entries in the records of the company. A copy of this written

agreement must be submitted to the CRA.

If an amount has been credited to the shareholder loan account as a result of an honest error and

the shareholder has not benefited from that error by drawing down on the shareholder loan

account, the entry may be corrected (reversed) in the corporate records. The auditor must obtain

from the corporation a copy of the entries required to reverse the credit in the shareholder loan

account.

Impact of the Franklin decision on audit policy

The CRA is of the view that the Franklin case was decided on its own facts. It should not be

considered as a general rule that a shareholder credit balance must be applied to offset a potential

subsection 15(1) benefit. Accordingly, the Franklin case should only apply to situations with

identical circumstances. Therefore, note that the Franklin decision does not impact the CRA's

reimbursement position stated above.

Therefore, the CRA's position is to continue to follow the existing policy concerning the

application of subsection 15(1). Auditors must distinguish the facts of the particular case from

those of Franklin. A strong factual case needs to be made that a benefit has been conferred. This

could be supported by such audit evidence as, for example:

• analysis of the number, nature, and quantum of transactions over a period of years

• degree of misrepresentation

• extent of personal financing on record

• shareholder credibility

• completeness and accuracy of books and records in general

• history of compliance issues

Documentation of the facts and the auditor’s conclusions are very important. Take steps to verify

the validity of any credit balance in the shareholder loan account.

Credits posted to the shareholder loan account

A benefit is generally conferred on a shareholder at the time a corporation becomes indebted to

the shareholder for nil or inadequate consideration (go to Kennedy v. MNR, 73 DTC 5359).

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However, the auditor must look beyond the journal entry to determine whether a benefit occurred

or not. In Bérubé v. The Queen, [1994] 1 CTC 2655, Judge Kempo, said:

"… accounting entries reflect rather than create reality, and that a mere bookkeeping entry in

a shareholder loan account does not in and of itself constitute a taxable benefit without

something more. …"

To determine whether a benefit was conferred, the auditor must decide if the credit posted to the

shareholder's account represents:

• a genuine transaction or an error;

• compensation, interest, rent, or dividends; or

• other amounts giving rise to a benefit.

Genuine transaction or error

Subsection 15(1) does not apply when a credit to the shareholder's loan account was made in

these circumstances:

• The error was made in good faith, that is, the shareholder or the corporation did not know

or would not have known that a credit had been posted to the shareholder loan account.

For example, in The Queen v. Robinson, 2000 DTC 6176 (FCTD), the incorrect

accounting entry made by the accountant without the shareholder's knowledge was not

considered a benefit that the corporation wanted to confer on a shareholder.

• The shareholder did not benefit from the error.

If an amount has been credited to the shareholder loan account as a result of an "honest error"

and the shareholder has not benefited from that error by drawing down on the shareholder loan

account, the entry may be corrected (reversed) in the corporate records. Obtain from the

corporation a copy of the entries required to reverse the credit in the shareholder loan account.

For the application of subsections 15(2) and 80.4(2), the correcting entry will be considered to be

effective on the date of the original entry.

Compensation, interest, rent, or dividend

A credit entry to the shareholder’s loan account relating to compensation, interest, or rent

generally constitutes a debt that may have been created for consideration of equal value and does

not constitute a benefit under subsection 15(1).

Compensation, interest (in certain cases), and dividends are taxable under section 5, paragraph

12(1)(c), and subsection 82(1) respectively, only when they are received. The amounts are

considered to have been received if the credit entry made to the shareholder loan account reduces

a debit balance (go to The Queen v. Ans, 83 DTC 5038 (FCTD)).

Examples

Example 1

Bonus or salaries $1,000

Shareholder loans $1,000

Comments

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Whether the amount was paid is a question of fact. A bonus or salary means withholdings for

Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) contributions/employment insurance

(EI) contributions/income tax are deducted and remitted to CRA. This is strong audit evidence

that an amount has been paid.

Example 2

Interest $1,000


Comments

If the shareholder loan accrues interest (normally indicated in written agreement), then

subsection 12(11) includes the loan in the definition of “investment contract.” If the shareholder

includes this as income per paragraph 12(1)(c) on the yearly anniversary of the loan as per

subsection 12(4), then the corporation would be allowed a deduction under paragraph 20(1)(c).

Example 3

Rent for a home office $1,000


Comments

The shareholder pays tax on the gross amount of rent, unless the activity constitutes a

commercial activity giving rise to a source of income, which would allow the shareholder to

claim reasonable expenses. Reasonable expenses involve the part of the residence that is used for

business.

The corporation may deduct the rent expense if it is reasonable in the circumstances. If the

corporation already has its own offices away from the shareholder's residence, the rent expense

may be disallowed under section 67.

The restriction on work space in the home expenses in subsection 18(12) does not apply to the

corporation, as it is available only to individuals.

Example 4

Dividend $1,000


Comments

Under subsection 82(1), the dividend is included in computing a taxpayer's income when it is

received.

Examples of other credit entries which may give rise to benefits

Example 1

Entertainment and travel $1,000


Comments

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This entry may represent a shareholder's personal expenses. If this is the case:

• the corporation may not deduct the expense according to paragraph 18(1)(a);

• the shareholder is taxable on the personal expenses claimed by the corporation according

to subsection 15(1);

• subsection 15(1.3) says the amount is to include taxes paid or payable and then Excise

Tax Act (ETA) section 173 generally says that if the corporation is a registrant, the

benefit is deemed a commercial supply and GST/HST has been collected. This means

that the corporation may claim an input tax credit (ITC) for the purchase of the supply

(travel), and must report the GST/HST portion of the benefit, as determined by the

equation in ETA section 173.

However, no adjustment to the corporation and the shareholder's incomes are necessary if the

expenses were incurred to earn business income.

Example 2

Bank $1,000


Comments

This entry may represent a deposit of business revenue to the corporation's bank account. If this

is the case:

• the deposit is added to the corporation's income and there may be GST/HST to remit on

this revenue if the revenue is consideration for a taxable supply;

• the shareholder may be taxable under subsection 15(1) on the amount credited, but as

there was no GST/HST taxable supply to the shareholder, section 173 of the ETA

imposes no further GST/HST liability on the corporation, as the benefit was money,

which is not considered a property or service for the ETA.

Example 3

Building $400,000


Comments

This entry may represent the price of a building the shareholder sold to the corporation for more

than the building's FMV. If this is the case:

• under paragraph 69(1)(a), reduce the cost to the corporation of the building by the

difference between the price paid and the FMV;

• tax the shareholder on the difference between the price paid and the FMV, as per

subsection 15(1);

• as the shareholder benefit did not result from a supply by the corporation to the

shareholder, subsection 173(1) of the ETA does not apply to the shareholder benefit

amount.

Case law

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There is considerable case law dealing with credits posted to the shareholder loan account,

including this useful reading:

• Tobis v. MNR, 81 DTC 126 • Toma v. The Queen, 95 DTC 5356

• Simons v. MNR, 85 DTC 105 • Smith v. The Queen, 96 DTC 1638

• Groeneveld v. MNR, 90 DTC 1211 • Cano v. The Queen, 97 DTC 993

• Franke v. The Queen, 94 DTC 1524 • Hrga et al. v. The Queen, 97 DTC 5165

• Penny v. The Queen, 95 DTC 5083 • Lee v. The Queen, 99 DTC 636

• Chopp v. The Queen, 95 DTC 527 • The Queen v. Robinson, 2000 DTC

6176

• The Queen v. Franklin, 2002 DTC

6803

Suppressed income of the corporation

Income suppressed by a corporation and appropriated by a shareholder will be taxed in that

person's hands under subsection 15(1) even though the funds may have been loaned back to the

corporation or used to repay a shareholder's debt to the corporation.

The amount subject to tax and penalty will be reduced by any reimbursement to the corporation

as long as the repayment is in accordance with the CRA's policy on voluntary disclosure.

As this represents income to the corporation, whether or not the shareholder pays the money

back, the corporation will still be reassessed for the amount of income not previously recorded.

Penalty

Consider applying penalties under subsection 163(2) against the corporation, the shareholder, or

both, particularly in respect of repeated non-compliance. The guidelines in 28.4.0 must be

followed in determining whether a penalty applies. If a penalty is not being applied, the

corporation and the shareholder must be advised in writing that a recurrence of the events could

result in a penalty to either or both of them.

In addition, since reassessments under subsection 15(1) sometimes involve the disposition of

property resulting in capital gains, the auditor must consider whether subsection 110.6(6) applies

to the transaction. Subsection 110.6(6) denies a capital gains deduction if an individual has

realized a capital gain on the disposition of capital property (this provision applies to "qualified

farm property" and "qualified small business corporation shares") in a tax year and "knowingly

or under circumstances amounting to gross negligence" fails to report the disposition on the

return for that year or fails to file a return for that year within one year after the due date. The

burden of proof is on CRA to justify the denial of the deduction.

24.10.5 Sale of property by a corporation to a shareholder


General comments

A corporation confers a benefit on a shareholder when it sells capital property to the shareholder

for less than its FMV. The value of the benefit is any excess of the FMV of the property over the

selling price. The benefit is usually taxable in the year the sale takes place.

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The FMV of the property is determined as of the date the transaction takes place. Depending on

the nature of the property, refer valuation questions to Real Estate Appraisal or Business Equity

Valuation, as necessary.

Go to 24.10.6, if the property sold comes from the corporation's inventory.

Income tax implications - Shareholder

When the shareholder acquires capital property from a corporation for an amount less than the

FMV, the auditor must consider:

• a benefit under subsection 15(1);

• an adjustment to the adjusted cost base (ACB) of the property the shareholder acquired;

• an adjustment to the capital cost of the property acquired by the shareholder.

On occasion, these transfers contain price adjustment clauses. Go to Income Tax Folio S4-F3-

C1, Price adjustment clauses, at www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s4/f3/s4-f3-c1-eng.html,

for comments relating to their effect on the application of subsection 15(1).

If the amount of an appropriation is related entirely to a question of valuation, the CRA's policy

on reimbursement must be considered. (Go to 24.10.4 section, Reimbursement policy.)

Adjustment to the adjusted cost base of the shareholder's acquired property

For capital gains purposes, any amount included in a shareholder's income under subsection

15(1) following the acquisition of capital property is added to the property's cost base under

subsection 52(1). This does not apply when the property the shareholder acquired is inventory or

an eligible capital property.

Adjustment to the capital cost of the shareholder's acquired property

If the price adjustment clause is accepted, then the shareholder's capital cost of the property is the

amount actually paid.

To determine the capital cost for section 13 or paragraph 20(1)(a), subparagraphs 13(7)(e)(ii) and

(iii) describe two scenarios. If the cost to the corporation is greater than to the shareholder, then

the shareholder’s cost is deemed to be the higher amount AND is deemed to have taken the

difference between the two as capital cost allowance (CCA) under paragraph 20(1)(a) in

previous periods. If the cost to the shareholder is greater than to the corporation, then ½ the

difference is added to the shareholder’s cost. (Essentially the gain that the corporation should

report, if that was the only asset in the pool.)

The rules set out in subsection 52(1) do not affect the capital cost for CCA purposes.

Income tax implications - Corporation

When the corporation sells capital property to a shareholder, the auditor must consider the:

• capital gain (loss); and

• recaptured depreciation or terminal loss.

The proceeds of disposition for the purposes of computing the capital gain (loss) may be

different than the agreed upon sale price between the parties. When the corporation disposes of a

property for a price below its FMV to a shareholder:


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• with whom the corporation was not dealing at arm's length or to a shareholder by way of

an inter vivos gift, the corporation shall be deemed, by paragraph 69(1)(b), to have

received proceeds of disposition equal to the FMV;

• and if the sale of the property at its FMV would have increased the corporation's income,

or reduced a loss of the corporation, the corporation is deemed to have disposed of the

property and to have received proceeds of disposition equal to its FMV, under subsection

69(4).

Leaseback of property sold by the corporation

In some cases, the sales contract calls for the property to be leased back to the corporation. As a

sale-lease back agreement involves two separate transactions (sale of property to the lessor and

the subsequent lease of the property to the original owner), the existence of the lease

arrangement will usually have no significant bearing on the amount of the appropriation. This

can be so even if the rental proceeds may be considerably less than the FMV rental. However,

view the transactions as one, unless there is tax avoidance. CRA reimbursement policy applies to

rents.

24.10.6 Inventory transferred from a corporation to a shareholder


A benefit is conferred on a shareholder under subsection 15(1) of the ITA when property from a

corporation's inventory is sold to a shareholder for proceeds less than FMV.

Fair market value of inventory

To determine the FMV of inventory, the auditor must consider:

• The FMV of the inventory may not be the same as the corporation's selling price to a

third party as the shareholder may be in a position to acquire the property from the

supplier at the same price the corporation paid for the property.

• When the shareholder provides inputs such as labour and materials at no cost, the FMV

of the corporation's property must not include the value of these inputs. In these cases, the

FMV may be established in one of the following two ways:

1. the property's inherent costs paid by the corporation; or

2. the property's total FMV reduced by the value of the shareholder's inputs.

• The FMV of the property may be its net realizable value if the property is outdated or

damaged so that the corporation must dispose of it at scrap value. The net realizable value

is equal to the selling price that the corporation would obtain in the normal course of

business less completion and sales costs that it can reasonably expect to pay.

If the FMV of individual inventory items is significant, consider a referral to Business Equity

Valuation or Real Estate Appraisal.


The value of the benefit conferred on a shareholder is the difference, if any, between the FMV of

the inventory and the amount the shareholder paid, if applicable. The GST/HST must be added to

the benefit according to subsection 15(1.3) when the inventory is not a tax-exempt or zero-rated

supply.

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The disposition of inventory results in business income, which is taxable under section 9.

When the corporation sells inventory to a shareholder for less than FMV, subsection 69(4) may

apply. In this case, the corporation is deemed to have disposed of the property for proceeds of

disposition equal to its FMV at that time. For the purposes of subsection 69(4) and

administratively for purposes of subsection 15(1), FMV will be determined to be the

corporation's replacement cost in most situations.

24.10.7 Theft or embezzlement by a shareholder


General comments

As indicated in paragraph 8 of Income Tax Interpretation Bulletin IT432R2, Benefits conferred

on shareholders, at www.cra-arc.gc.ca/E/pub/tp/it432r2/README.html, the word "benefit,"

used in subsection 15(1) of the ITA, has a meaning wide enough to include funds or property of

a corporation stolen or embezzled by a shareholder. However, subsection 15(1) requires not only

that there be a benefit to the shareholder, but also that it be conferred on the shareholder by the

corporation.

If the shareholder and the corporation are not dealing at arm's length, the CRA assumes that any

theft or embezzlement of corporate funds or property by the shareholder would be with the

concurrence of, and therefore would result in a benefit conferred by, the corporation.

If the shareholder and the corporation are dealing at arm's length, any theft or embezzlement of

corporate funds or property by the shareholder would normally be without the corporation's

agreement. In which case, there would be no benefit conferred by the corporation (this could

happen, for example, if the shareholder is a minority shareholder). If a subsection 15(1) benefit

does not occur, a theft or embezzlement is generally taxable according to the rules discussed in

Income Tax Interpretation Bulletin IT256R, Gains from theft, defalcation, or embezzlement, at

www.cra-arc.gc.ca/E/pub/tp/it256r/README.html.

Deductibility of losses - Corporation

The deductibility of losses from the theft or embezzlement of funds by a shareholder is based on

the specific circumstances of each case. When subsection 15(1) applies to the shareholder, the

corporation cannot deduct the losses.

For more information on the treatment of corporate losses, go to Income Tax Interpretation

Bulletin IT185R-CONSOLID, Losses from theft, defalcation, or embezzlement, at www.cra-

arc.gc.ca/E/pub/tp/it185r-consolid/README.html.

The shareholder will be taxed even though the corporation may recover part or all of its loss

from an insurer. If the corporation is not entitled to deduct the loss, insurance recoveries will not

constitute income in its hands.

24.10.8 Sale of property by a shareholder to a corporation


If a shareholder sells property to a corporation at a price that exceeds the FMV of the property,

the amount subject to tax under subsection 15(1) of the ITA will be the amount of this excess.

The FMV of the property is determined as of the date the transaction takes place.


http://www.cra-arc.gc.ca/E/pub/tp/it256r/README.html



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Consider these income tax implications:

• if the property is a share, whether a benefit under subsection 15(1) or a deemed dividend

according to section 84.1 is applicable;

• capital gain or loss; and

• recapture or terminal loss.

The benefit conferred on the shareholder under subsection 15(1) may be reduced or cancelled if:

• the CRA approves the adjustment of the sale price when a price adjustment clause applies

to the transaction (go to 24.10.4 section, Price adjustment clauses);

• the benefit stems entirely from a valuation and the shareholder wants to reimburse the

corporation according to CRA's reimbursement policy (go to 24.10.4 section,

Reimbursement policy).

Inclusion of the benefit in the shareholder's income

As a rule, the shareholder will be subject to tax with respect to a subsection 15(1) benefit from

the sale of property by the shareholder to the corporation in the year the sale takes place. This is

applicable even if a liability to the shareholder has been recorded in the accounts of the

corporation with only a portion, if any, of the purchase price actually having been paid to the

shareholder.

The amount, which will be taxed in that year, will depend upon the security of the debt held by

the shareholder. If the debt is completely secured (that is, the corporation has the capacity to pay

the debt in full), the benefit will be taxed under subsection 15(1) in the year of sale. The actual

receipt of the funds at some later date would not result in additional income to report.

If the debt is not completely secured, the amounts subject to tax in the year it was created and in

the following years will be the subsection 15(1) amounts paid or secured in the year, as the case

may be (that is, there should not be a subsection 15(1) amount outstanding, which is both secured

and untaxed).

In order to ensure that tax is levied only on the benefit or advantage actually conferred on the

shareholder as a result of the sale, consider a referral to Business Equity Valuation to determine

the FMV of the debt.

Capital gain or loss

If depreciable or non-depreciable property is sold at a price greater than the shareholder's capital

cost or ACB of the property, the amount of the capital gain that would otherwise be recognized

on the sale is, according to paragraph 39(1)(a), reduced by the amount of the appropriation

determined under subsection 15(1). This adjustment is necessary to eliminate double taxation.

Recapture or terminal loss

The amount of recapture that is added to the shareholder's income under subsection 13(1) on the

transfer of depreciable property to a corporation is reduced by the amount of the subsection 15(1)

appropriation remaining after first reducing any capital gains realized on the disposition. The

reduction to the recapture is in accordance with subsection 248(28), which is intended to prevent

double taxation.

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Tax implications - Corporation

When a corporation acquires property from a shareholder with whom the corporation was not

dealing at arm's length for a price higher than the FMV of the property, consider these income

tax implications:

• In accordance with paragraph 69(1)(a), the corporation is deemed to have acquired the

property at its FMV.

• The capital cost of a depreciable property is determined by applying paragraph 13(7)(e).

Subparagraph 13(7)(e)(i) applies when the acquisition price exceeds the shareholder's

capital cost of the depreciable property.

Examples

Example 1

This example illustrates the amount that will be taxed in a year under subsection 15(1) when a

corporation becomes indebted to the shareholder on the purchase of property from the

shareholder and the debt is not completely secured (the corporation does not have the capacity to

pay the debt in full).

Facts

A Ltd. began operations on January 1, 2013. The company's balance sheet at that date was

comprised of $1 in cash and capital stock of $1.

The same day, Mr. A sold land to A Ltd. for $200,000 in exchange for a $200,000 note. The note

was secured by the land, which had a FMV of $150,000 at that time.

The FMV of the note, at this time, with no other assets or liabilities, is equal to the FMV of the

land less the cost to seize the land ($2,000).

Tax implications for the shareholder

A benefit under subsection 15(1) will not be taxed in a year when the FMV of the debt is less

than the FMV of the property received from the shareholder.

The benefit is calculated as follows:

FMV of the debt $148,000 ($150,000 – 2,000)

Less:

FMV of the land 150,000

Benefit Nil

If the financial position of the corporation improves in a subsequent year, the amount subject to

tax will be the portion of the subsection 15(1) amount that is secured in the year. For example, if

the FMV of the note is $180,000 in year 2, the benefit would be $30,000 (180,000 – 150,000).

Tax implications for the corporation

The cost of the land is deemed to be $150,000, which is its FMV according to paragraph

69(1)(a).

Example 2

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Sale of property by a shareholder to the corporation.

Facts

Mr. A is the sole shareholder of A Ltd. On March 5, 2013, he sold a building (depreciable

property) to A Ltd. for $480,000. The capital cost of the building was $285,000, the FMV was

$320,000, and the undepreciated capital cost (UCC) was $123,000. Real Estate Appraisal

accepted the FMV of the building.

Tax implications for the shareholder

Benefit according to subsection 15(1)

Proceeds of disposition $480,000

Less: FMV 320,000

Benefit $160,000

Capital gain

Proceeds of disposition $480,000

Less: Capital cost 285,000

Gain $195,000

Capital gain prior to adjustment $195,000

Less: paragraph 39(1)(a) adjustment (re: subsection 15(1) benefit) 160,000

Adjusted capital gain $ 35,000

Taxable capital gain (50% section 38) $ 17,500

Recaptured amount

UCC $123,000

Less: lesser of the proceeds of disposition and the capital cost 285,000

Recapture $162,000

Note: The full amount of the subsection 15(1) benefit ($160,000) was deducted in

accordance with paragraph 39(1)(a) in determining the capital gain. Consequently, no

amount remains that is being taxed twice which would require the recapture on the

disposition to be reduced according to subsection 248(28).

Tax implications for the corporation

ACB of the building under section 54

Deemed acquisition cost under paragraph 69(1)(a) $320,000

Adjustment of the building's capital cost according to subparagraph

13(7)(e)(i)

Mr. A's capital cost $285,000

Add: ½ of the following difference, if any:

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Mr. A's proceeds of disposition $480,000

Less: Mr. A's capital cost 285,000

$195,000 97,500

Revised capital cost for CCA purposes $382,500

24.10.9 Use of corporation's property


General comments

If corporate property is made available for the personal use of a shareholder, a benefit under

subsection 15(1) is considered to have been conferred on the shareholder. This is so, whether or

not the shareholder paid a portion of the cost of the property or any related operating expenses.

In addition, whether the corporation has claimed any CCA on the property is not relevant.

Depending on the circumstances, subsection 15(1) may be applied in conjunction with the

provisions of subsection 56(2) if a payment or transfer of property is made to a person, at the

discretion or concurrence of the shareholder.

For more information relating to subsection 56(2), go to:

• Income Tax Interpretation Bulletin IT335R2, Indirect payments, at www.cra-

arc.gc.ca/E/pub/tp/it335r2/README.html; and

• 24.11.0, Indirect payments and benefits.

Determining the value of the benefit

The decision in Youngman v. The Queen, 1990 (FCA) 90 DTC 6322, is important for

determining the value of a benefit conferred on a shareholder. The court stated the following:

"In order to assess the value of a benefit…it is first necessary to determine…what the

company did for its shareholder; second, it is necessary to find what price the shareholder

would have to pay, in similar circumstances, to get the same benefit from a company of

which he was not a shareholder".

The calculation of the value of the benefit is usually based on the fair market rent for the

property minus any consideration paid to the corporation by the shareholder for use of the

property. The fair market rent is most often equal to the rental value of a comparable asset. The

fair market rent may not, however, always be appropriate for measuring the benefit, particularly

if it does not provide for a reasonable return on the value or cost of the property. This may be the

case, for example, for a luxury residence or yacht made available for the shareholder's personal

use. In such a case, a rental value will have to be imputed and negotiations undertaken with the

taxpayer to arrive at a reasonable amount having regard to all the circumstances.

Imputed value of the benefit

The imputed value would be the rent that a potential lessor (the corporation) would demand from

an arm's length person to induce the corporation to purchase the particular property for the

purpose of renting it to that person. The imputed value is determined by multiplying a normal

rate of return (to be determined by Business Equity Valuation or Real Estate Appraisal) times the

greater of the cost or FMV of the property (a referral to Business Equity Valuation or Real Estate



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Appraisal may be required) and adding the operating costs (other than interest paid on liabilities

connected with the property) related to the property. The total of these two amounts is often

referred to as imputed rent. Any consideration paid to the corporation by the shareholder for the

use of the property is subtracted from the imputed rent. When using this formula, the amount

representing the greater of the cost or FMV of the property may first be reduced by any

outstanding interest-free loans or advances to the corporation made by the shareholder to enable

the corporation to acquire the property before multiplying by the normal rate of return.

Other criteria that will be considered by Business Equity Valuation or Real Estate Appraisal in

determining imputed value include:

• A lessor's expected return on a rental property may not only be the lease payments, but

also the anticipated appreciation on the property; to the extent that the lessor expects the

property to rise in value, the lessor may be prepared to accept lower lease revenue.

• A rental amount that now appears unreasonably low may have been quite reasonable at

the time the shareholder first moved in, and it may be appropriate to conclude that the

arrangement was intended to be a long-term one.

A negotiated settlement should not, in most cases, be markedly lower than the imputed value. If

an agreement with the shareholder cannot be reached after considering all the facts, the

assessment under subsection 15(1) should be issued on an amount equal to the imputed value

minus any rent paid.

A negotiated settlement may be less than the imputed value when the property was not acquired

mainly for the shareholder's personal use. For example, when a property, initially acquired for

business reasons, is subsequently held for the shareholder's personal use, consider any decrease

in the FMV of the property a reduction in the imputed value.

The imputed value method is not designed to penalize a shareholder by taxing a premium over

the FMV as determined on an arm's length basis. It is an alternate method of determining

arm's length fair market rental when comparables are not available.

Benefit calculation period

When a corporation acquires property primarily (more than 50%) for business purposes and the

shareholder's use is only incidental, the value of the taxable benefit will be based on the actual

use of the property by the shareholder during the year.

On the other hand, when a corporation acquires property primarily (more than 50%) for the

shareholder's personal use, the time the shareholder actually uses the property is not relevant in

determining the value of the benefit. The value of the taxable benefit is based on the length of

time in the year the property was made available to the shareholder, less the time the property

was used for business purposes.

To determine if the property was acquired for business purposes, the auditor must review the

terms and conditions of the property's use by the shareholder. When the decision to purchase the

property was made primarily for the shareholder's personal use rather than for business

purposes, it can be assumed that the property was acquired for the shareholder's personal use.


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No deduction on account of operating expenses in respect of the property will be allowed to the

corporation, except to the extent of the rent, if any, paid by the shareholder, if the property was

not acquired for the purpose of gaining or producing income.

If the property was acquired for the shareholder's exclusive personal use, it is not considered

property acquired for the purpose of gaining or producing income. As a result, under paragraph

1102(1)(c) of the Income Tax Regulations, these types of assets cannot be included in an asset

class for the purposes of computing CCA.

The rules in subsections 13(7) and 45(1) of the ITA must be considered in the following

circumstances:

• A property is used for more than one purpose.

• The relationship between the property's use for gaining income and another use changes.

24.10.10 Use of specific types of corporate property - Commentary and examples


Aircraft

If an aircraft, which is owned or leased primarily for business purposes, makes a flight for

business reasons and a shareholder occupies available space on the aircraft for personal reasons,

the shareholder derives a taxable benefit. In these cases, the value of the benefit, which must be

included in the income of the shareholder, is the equivalent regular commercial economy airfare

for a regularly scheduled flight to the same destination. Refer unusual cases to Technical Section,

Business Audit Division, Small and Medium Enterprises Directorate in Headquarters.

When an aircraft is maintained by a corporation primarily for the personal use of one or more

shareholders, the value of the benefit will be determined based on the facts of each case and the

guidelines set out in this subchapter will help in determining the taxable benefit.

Yacht

Example 1

Facts

On January 1, 2011, Holdco bought a yacht for the personal use of its majority shareholder. A

weekly fair market rent is not available because it is a deluxe boat. The yacht was available for

the shareholder's personal use 353 days in 2011, that is, every day except for the 12 days the

yacht was rented to Subco. The $10,000 in rental income was debited to the account payable

owing to the shareholder. The yacht's FMV at December 31, 2011, was $270,000.

The interest rate in each quarter of 2011 was 3% according to Regulation 4300.

A reasonable rate of return for this company at this time (provided by Business Equity Valuation

or Real Estate Appraisal) is 12%.

The financial statements for the period ending December 31, 2011, indicate:

Balance Sheet

Assets: Yacht (at cost) $300,000

Liabilities:

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Bank loan (to buy the yacht) $100,000

Shareholder loan (to buy the yacht) $100,000 interest-free

Accounts payable to the shareholder (other than the

yacht)

$200,000 interest-free

Income Statement

Rental income from the shareholder $10,000 days used = 24

Rental income from Subco 3,000 days used = 12

Gross rental income $13,000

Operating expenses $7,000

Maintenance costs 5,000

Interest on bank loan 11,000

Depreciation 10,000

Total expenses $33,000

Net loss from rental of yacht $20,000


Since the main use of the yacht is personal, the shareholder is subject to a taxable benefit under

subsection 15(1). The taxable benefit is calculated on the number of days the yacht was available

for the personal use of the shareholder, that is, 353 days in 2011.

The value of the benefit is determined as follows: Note

Return on the greater of cost or FMV of the yacht $300,000 x .12 $36,000

Less: Imputed interest on shareholder's loan to the

corporation

Plus: Operating and maintenance expenses less

incidental business use

$100,000 x .03 3,000 1

$33,000

$12,000 x 353/365 days 11,605 2

Imputed amount $44,605

Less: rent charged to the shareholder 10,000

Benefit under subsection 15(1) $33,605

Note 1

The benefit to the shareholder is reduced by the imputed interest on the shareholder's loan of

$100,000 to the corporation, which was used to assist in purchasing the yacht. The reduction is

used in calculating the benefit as long as the corporation has not repaid the loan.

Note 2

Interest costs on the bank loan are not added because the normal return includes interest.

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Income tax implications – Holdco

If the yacht was not acquired for the purpose of gaining or producing income, the costs

associated with the yacht are not deductible. If they are not incurred in the ordinary course of

Holdco’s business of providing the yacht for hire or reward, the operating and maintenance

expenses are not deductible according to paragraph 18(1)(l) of the ITA. Paragraph 1102(1)(f) of

the Regulations does not allow CCA to be taken if paragraph 18(1)(l) applies to disallow the

expenses.

Go to Income Tax Interpretation Bulletin IT148R3, Recreational properties and club dues, at

www.cra-arc.gc.ca/E/pub/tp/it148r3/README.html, for more information concerning the

deduction of expenses incurred for a yacht.

Income tax implications - Subco

The $3,000 expense in 2011 for the use of the yacht is not deductible under paragraph 18(1)(l).

Example 2

Facts

1. The Saskatchewan corporation is controlled by a shareholder who is also its president and

director.

2. The corporation owns a jet ski that cost $20,000 plus $1,000 PST and $1,000 GST for a

total of $22,000.

3. A loan, with interest payable at 8% per annum, was used to purchase the jet ski.

4. The jet ski is for the shareholder's exclusive use and the corporation does not charge rent

or for costs.

5. The corporation deducted $1,760 in interest expense and CCA of $3,150 (Class 7 at 15%

x $21,000 (includes PST)).

6. The corporation annually paid and expensed (except the GST) $500 jet ski insurance and

$500 + $25 GST for repairs and maintenance.

7. ITCs of $1,000 and $25 were claimed by the corporation with respect to the jet ski.

8. Assume the reasonable rate of return for calculating the interest benefits is 8% per

annum.

Income tax implications

Company Deductions Disallowed Shareholder Taxable Benefits

Description Amount Reference Description Amount Reference

Jet ski CCA $3,150 18(1)(b)

Jet ski loan

interest

1,760 18(1)(b) Jet ski standby

benefit

$1,760 15(1)

Jet ski

insurance

500 18(1)(a) Jet ski

operating

1,025 15(1)


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benefit

Jet ski repairs

and

maintenance

500 18(1)(a)

Total $5,910 Total $2,785

The company is not allowed to deduct interest expense, depreciation, or operating costs for tax

purposes, as they were not incurred for the purpose of earning income.

The shareholder has an availability (or "standby") benefit equal to what the company would have

charged an arm's length user. This rental value may be imputed based on a reasonable rate of

return on the invested capital of the company. In this case, the amount or value of the benefits

would be 8% of $22,000 or $1,760 per year, plus a $1,025 operating cost benefit. Note that the

rental benefit is based on the corporation's tax-included (PST and GST) cost of the jet ski, and

the operating benefit is based on the tax-included (PST and GST) operating costs (subsection

15(1.3)).

Case law

• The Queen v. Houle, 83 DTC 5430 (FCTD)

• Woods v. MNR, 85 DTC 479 (TCC)

• Wallace et al. v. MNR, 86 DTC 1228 (TCC)

• Check et al. v. MNR, 87 DTC 73 (TCC)

• Mid-West Feed Ltd. v. MNR, 87 DTC 394 (TCC)

• Smith v. MNR, 91 DTC 909 (TCC)

Building (condominium, residence, other)

When capital real property is for the exclusive use of the shareholder, the courts have generally

considered that shareholders must pay a fair market rent based on an entire year (or the period it

was "available for use") if a shareholder uses the building for only part of the year.

A benefit related to a property acquired for business purposes, but also used by a shareholder

personally, will likely be calculated based on the number of actual days of use. The fair market

rent of a comparable property, prorated for the period of use and increased by the addition of

related expenses, will be used to calculate the benefit.

Example 1 - Value of the benefit based on fair market rent

Facts

1. Alpha Corporation purchased a new residential condominium, both for business purposes

and for the personal use of its sole shareholder and his family.

2. The shareholder, Mr. Beta, and his family use the condominium during his children's

summer holidays, from June 1 to August 31. Mr. Beta pays the corporation $200 for each

month he uses the condominium.

3. The operating costs of the condominium are almost $400 per month.

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4. During the rest of the year, the condominium is continuously rented to various parties

with whom the corporation deals at arm's length for $900 per month.


According to subsection 15(1), Mr. Beta would be required to include in his income a benefit

equal to:

Fair market rent 3 months x $900 $2,700

Less: consideration paid 3 months x $200 600

Taxable benefit $2,100

Income tax implications for the corporation

The net rental income of $4,500 will be included in the corporation's income and is calculated as:

Gross rental income [($900 x 9) + ($200 x 3)] $8,700

Less: expenses iNote 1 [($400 x 9) + ($200 x 3)] 4,200

Net rental income before CCA iiNote 2 $4,500

Example 2 - Value of the benefit based on the imputed value

Facts

1. A Ltd., a registrant, is a steel manufacturer. In 2012, the corporation purchased a deluxe

condominium for $1,250,000, plus GST, for the exclusive use of its sole shareholder,

Mr. A.

2. Mr. A made a $500,000 interest-free loan to the corporation to enable it to buy the

condominium.

3. The FMV of the condominium was $1,340,000 in 2013

4. The $46,000 in maintenance costs in 2013 were paid by the corporation and reimbursed

by Mr. A at the end of the year.


The value of the benefit to be included in computing Mr. A's 2013 income is based on imputed

value and is calculated as follows:

Reasonable rate of return for the calculation of the interest (provided by Business Equity

Valuation or Real Estate Appraisal) multiplied by the greater of:

The cost less the reduction: $1,250,000 - 500,000 = $750,000

The FMV less the reduction: $1,340,000 - 500,000 = $840,000

$840,000 x 9% = $ 75,600

Plus: Operating expenses 46,000

Imputed rent $121,600

Less: Consideration paid by Mr. A 46,000

Benefit according to subsection 15(1) $ 75,600

27

Published May 2015


The corporation is not eligible to claim any expenses regarding the condominium according to

paragraph 18(1)(a) of the ITA. CCA is not allowed according to paragraph 1102(1)(c) of the

Regulations.

Case law

• Soper v. MNR, 87 DTC 522 (TCC)

• Dudelzak v. MNR, 87 DTC 525 (TCC)

• Gendron et al. v. MNR, 89 DTC 575 (TCC)

• Wilfred L. Giffin et al. v. MNR, 91 DTC 421 (TCC)

• Smith v. MNR, 91 DTC 909 (TCC)

• Tremblay v. MNR, 91 DTC 1012 (TCC)

• McHugh et al. v. The Queen, 95 DTC 778 (TCC)

• The Queen v. Fingold, 97 DTC 5449 (FCA)

• Corriveau v. The Queen, 99 DTC 344 (TCC)

Automobile

When a corporation makes an automobile available to a shareholder or to a person related to a

shareholder, the shareholder must include in income the value of the benefit derived from the

automobile. Under subsection 15(5), the calculation of the taxable benefit is the same as the

calculation when an automobile is made available to an employee. For more information, go to

27.10.0.

24.10.11 Additions or improvements to shareholder's property


Shareholder's property leased to the corporation

Income tax implications

Income Tax Interpretation Bulletin IT432R2, Benefits Conferred on Shareholders, at www.cra-

arc.gc.ca/E/pub/tp/it432r2/README.html, paragraph 10, describes the tax effect of additions

and/or improvements to a building owned by a shareholder and rented to the corporation. The

same guidelines would apply to other property leased to the corporation.

When the amount subject to tax depends upon the increase in FMV of the property related to the

additions or improvements, refer the valuation of this increase to Business Equity Valuation or

Real Estate Appraisal before an assessment is issued.

Benefits determined by means of a valuation may be further affected by the use of the CRA's

reimbursement policy. The shareholder will be allowed to correct the situation in any way

consistent with our policies, including the transfer of the property to the corporation. If the

shareholder reimburses the corporation, there will be an increase in that person's capital cost of

the property by the amount of the reimbursement and a corresponding decrease in the cost of the

leasehold improvement to the corporation.



28

Published May 2015

If the corporation carries on a construction business, and the corporation constructed additions or

improvements, subsection 69(4) will apply to the corporation and the FMV of the addition or

improvement will be a determining factor in respect of the benefit to the shareholder.

If an addition or improvement vests in the owner of the building, a benefit is considered to have

been conferred on the shareholder by the corporation. The amount of the benefit is considered to

be the present value of the amount, if any, by which the addition or improvement increases the

value of the building to the shareholder at the time the building reverts to the shareholder. This

includes factors such as:

• the nature of the improvements;

• the terms of the lease;

• renewal or extension provisions (normally CRA considers the first option period as part

of the lease); and

• the rent charged.

If the terms of the lease are later changed in favour of the shareholder or if the lease is annulled

before the expiration of its term, a benefit would be created at that time equal to the increase in

the shareholder's reversionary interest created by the alteration or cancellation of the lease.

Additions or improvements may not vest in the lessor as, for example, in the case under an

emphyteutic lease. Further, it is possible, in some provinces, for the land and building to be

owned by different persons. If there may be doubt as to whether a benefit has been conferred,

refer the matter to Technical Section, Business Audit Division, Small and Medium Enterprises

Directorate, Compliance Programs Branch.

The corporation may obtain a deduction under paragraph 1100(1)(b) or subsection 1102(5) of the

Regulations regarding the improvements made to the property it leases from the shareholder

despite the shareholder being subject to tax on the improvements under subsection 15(1) of the

ITA. For more information on the possible deduction, go to Income Tax Interpretation Bulletin

IT464R, Capital cost allowance - Leasehold interests, at www.cra-

arc.gc.ca/E/pub/tp/it464r/README.html.

Shareholder's property not leased to the corporation

If a corporation makes improvements to a shareholder's property, which it is not renting, the

shareholder will be taxed under subsection 15(1) on the actual cost of the addition or

improvement.

The amount subject to income tax in a particular year will be that portion of the addition or

improvement completed during the year.

If the nature of the business ordinarily carried on by the corporation includes construction, and

the corporation made the additions or improvements, subsection 69(4) will apply to the

corporation and the FMV of the addition or improvement will be a determining factor in respect

of the benefit to the shareholder. If the FMV is much less than cost, deal with the particular

circumstances on an individual basis.

The corporation cannot deduct the cost of the additions or improvements since they were not

made to gain or produce income.



29

Published May 2015

24.10.12 References


Income Tax Folio

• S4-F3-C1, Price adjustment clauses, at www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s4/f3/s4-

f3-c1-eng.html

Income Tax Interpretation Bulletins

• IT96R6, Options granted by corporations to acquire shares, bonds, or debentures and by

trusts to acquire trust units, at www.cra-arc.gc.ca/E/pub/tp/it96r6/README.html

• IT116R3, Rights to buy additional shares, at www.cra-

arc.gc.ca/E/pub/tp/it116r3/README.html

• IT148R3, Recreational properties and club dues, at www.cra-


• IT185R-CONSOLID, Losses from theft, defalcation, or embezzlement, at www.cra-

arc.gc.ca/E/pub/tp/it185r-consolid/README.html

• IT256R, Gains from theft, defalcation, or embezzlement, at www.cra-

arc.gc.ca/E/pub/tp/it256r/README.html

• IT421R2, Benefits to individuals, corporations, and shareholders from loans or debt, at

www.cra-arc.gc.ca/E/pub/tp/it421r2/README.html

• IT432R2, Benefits conferred on shareholders, at www.cra-


• IT464R, Capital cost allowance - Leasehold interests, at www.cra-


Advance Tax Ruling

• Cancelled ATR-9, Transfer of Personal Residence from Corporation to its Controlling

Shareholder

Income Tax Rulings

• Document No. 9317025, June 15, 1993, Shareholder Benefit

• Document No. 9728755, November 6, 1997, Benefit Conferred on Issuance of Shares

• Document No. 9807817, August 31, 1998, Appropriation and Recapture

Tax & Charities Appeals Directorate (TCAD) Decision Details

• ITC-96-035 / ITC-96-035R, J. Paul Fingold

• ITC-98-005, John Chopp

• ITC-93-021 / 93-021R, David Robinson

• ITC-00-036 / 2000-36R, John Franklin

Jurisprudence

• Bernstein v. MNR, 1977 (FCA) 77 DTC 5187

















http://sh0zapdb0393:8500/Production/WBA039/index.cfm?event=1_2_p&Product_type=ITC_decisions&Product_number=96035_1&lang=eng

http://sh0zapdb0393:8500/Production/WBA039/index.cfm?event=1_2_p&Product_type=ITC_decisions&Product_number=96035R_1&lang=eng





30

Published May 2015

• Berube v. The Queen, 1994, 1 CTC 2655

• Cano v. the Queen, 1997 (TCC) 97 DTC 993

• The Queen v. Chopp, 1998 (FCA) 98 DTC 6014

• The Queen v. Fingold, 1997 (FCA) 97 DTC 5449

• The Queen v. Franklin, 2002 (FCA) 2002 DTC 6803

• Groeneveld v. MNR, 1990 (TCC) 90 DTC 1211

• Hickman Motors Ltd. v. the Queen 1998 (SCC) 97 DTC 5363

• Kennedy v. MNR, 1973 (FCA) 73 DTC 5359

• The Queen v. Leslie, 1975 (FCTD) 75 DTC 5086

• Youngman v. the Queen, 1990 (FCA) 90 DTC 6322

• Vine et al. v. the Queen, 1989 (FCTD) 89 DTC 5528

Other

• Training product TD1018-000, Transactions between a Corporation and its Shareholders

A significant portion of the commentary in this subchapter was taken from Taxation

Operations Manual (TOM) 13(15)0, Appropriation of Property to Shareholder. TOM 13(15)0

has been taken out of circulation.

24.11.0 Indirect payments and benefits




This subchapter discusses subsections 56(2) and 246(1) of the ITA.

If a benefit has been conferred, but not to a direct shareholder, subsection 15(1) won’t apply, but

the provisions of subsection 56(2) or subsection 246(1) may apply, if the benefit was made at the

shareholder’s direction or with the shareholder’s concurrence or acquiescence. The purpose of

these sections is to prevent tax avoidance which might result when amounts which would

constitute income when received by a particular taxpayer are paid to another person.

Subsection 56(2) applies to arm’s length and non-arm’s length transactions.

Read this subchapter together with Income Tax Interpretation Bulletin IT335R2, Indirect

payments, at www.cra-arc.gc.ca/E/pub/tp/it335r2/README.html. Also refer to:

• 24.10.0, Benefits conferred on shareholders; and

• Training product TD1018-000, Transactions between a Corporation and its

Shareholders.


24.11.3 Income tax implications


Subsection 56(2) of the ITA

http://druid/dlp/crses-e.asp?course_code=TD1018-000



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Published May 2015

Subsection 56(2) is intended to cover cases if a taxpayer seeks to avoid the receipt of what would

otherwise be income in the taxpayer’s hands, by arranging to have the payment or transfer of

property made to some other person, either for the taxpayer’s own benefit or for the benefit of

another person.

As indicated in Income Tax Interpretation Bulletin IT335R2, Indirect payments, at www.cra-

arc.gc.ca/E/pub/tp/it335r2/README.html, subsection 56(2) will cause an amount not received

by a taxpayer to be added to the taxpayer’s income if these conditions are met:

• There is a payment or transfer of property to a person other than the taxpayer.

• The payment or transfer is according to the direction of or with the concurrence of the

taxpayer (this may be implicit).

• There is a benefit to the taxpayer or a benefit the taxpayer wishes to confer on the other

person.

• The taxpayer would have been taxable on the amount under some other section of the

ITA if it had been paid to the taxpayer.

Subsection 56(2) provides for an exemption from its application for any portion of a retirement

pension that is assigned from one spouse or common-law partner to another according to section

65.1 of the Canada Pension Plan or a comparable provision of a provincial pension plan, as

defined in section 3 of that Act or of a prescribed provincial pension plan.

In order to reassess under subsection 56(2), there must be a payment or transfer of property.

"Property" is defined in subsection 248(1) to mean, "property of any kind whatever whether real

or personal or corporeal or incorporeal and, without restricting the generality of the foregoing,

includes a right of any kind whatever, a share or a chose in action,… ". According to the Tax &

Charities Appeals Directorate (TCAD) Decision Details ITC-97-035 (January 22, 1998), if the

use of corporate property is made available by a shareholder to some other person who is not a

shareholder of the corporation, and no enforceable right to use the property such as a lease, sale,

or gift has been transferred, the CRA cannot apply 56(2). Legal services of the Department of

Justice and the Income Tax Rulings Directorate support this decision.

The wording of subsection 15(1) “benefit conferred on a taxpayer” and part of subsection 56(2)

“for the benefit of the taxpayer” are similar. At times, when a third party is involved, it may not

be clear whether the benefit was direct or indirect and CRA may use both subsections in

conjunction. If a corporation, for no equal consideration, makes a payment on a debt of a

shareholder to a third party, the payment is taxed in the shareholder’s hands according to

subsections 56(2) and 15(1), provided the payment was not charged to salary or to the

shareholder’s loan account.

If the corporation incurs a liability to a third party in respect of goods or services supplied by the

third party to a shareholder, the time the liability was incurred, rather than the date of the

payment in respect of that liability, is when the benefit was conferred on the shareholder.

Example 1

Facts

Mr. Farmer is the sole shareholder of a corporation that owns a farm property. The farm property

is no longer used in the corporation’s business.




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Published May 2015

Mr. Farmer allows his daughter, Eloise, and her family to occupy the farm property and farm

part of the land. Eloise does not pay rent for the use of the property, but she pays the property

taxes and is responsible for the general upkeep and maintenance of the property.

Implications

In order for subsection 56(2) to apply, a payment or transfer of property made according to the

direction of, or with the concurrence of the corporation or Mr. Farmer, to Eloise, as a benefit that

either the corporation or Mr. Farmer desired to have conferred on Eloise, must have occurred. In

the example, the corporation did not make a payment or a transfer of property to the daughter.

Unless the corporation grants an enforceable legal right to use the property (for example, a

lease), the CRA cannot substantiate for reassessment purposes, that a transfer of property

occurred. The fact that the daughter was allowed to use the property does not, in itself, mean that

the daughter acquired the right to occupy the property.

Example 2

Facts

During the 2011, 2012, and 2013 taxation years the taxpayer, Mr. Benito, was the sole

shareholder of B Inc. During those years, B Inc., at Mr. Benito’s direction, paid out various sums

to his friend, Ms. Charles. The amounts in question totalled $80,000. These amounts were not set

up as loans.

Tax implications

The $80,000 is included in Mr. Benito's income for the years 2011 to 2013 according to

subsections 15(1) and 56(2).

Subsection 56(2) applies for each particular taxation year for the following reasons:

• A payment was made to Ms. Charles.

• The payment was made according to the direction of the taxpayer.

• The payment was made as a benefit that the taxpayer desired to have conferred on

Ms. Charles.

• The amount of the payment would have been included in the taxpayer's income had the

payment been made directly to the taxpayer (that is, as a subsection 15(1) benefit).

The above facts are based on the court decision in Cohen v. the Queen, 1996 (TCC) 96 DTC

1454, where Ms. Charles indicated that the money was used both for her sole benefit as well as

for the benefit of Benito and Charles as a couple.

Dividends

As stated in paragraph 9 Income Tax Interpretation Bulletin IT335R2, Indirect payments, at

www.cra-arc.gc.ca/E/pub/tp/it335r2/README.html, subsection 56(2) does not generally apply

to dividend income since, until a dividend is declared, the profits belong to the corporation as

retained earnings. However, subsection 56(2) may be applicable if dividends are paid to

shareholders of a corporation who, having regard to the dividend entitlements of their shares as

set out in the articles of incorporation, receive dividends to which they are not entitled and/or if

another taxpayer has a pre-existing entitlement to the dividend income paid to shareholders of a

corporation.


33

Published May 2015

The above paragraph reflects the decisions of the Supreme Court of Canada in Neuman v. MNR,

(1998) 98 DTC 6297, and in The Queen v. McClurg, (1991) 91 DTC 5001.

Tax avoidance provision - Subsection 246(1) of the ITA

Subsection 246(1) provides that if a person confers a benefit on a taxpayer, either directly or

indirectly, the amount of the benefit is included in the taxpayer's income. Subsection 246(1),

however, does not apply unless the amount would have been included in the taxpayer's income if

it were a payment made directly to the taxpayer. A benefit is included in the taxpayer's income or

deemed to be a payment made for purposes of Part XIII when these conditions are met:

• A person confers a benefit, either directly or indirectly, by any means whatever, on a

taxpayer.

• The amount of the benefit is not otherwise included in the taxpayer's income or taxable

income earned in Canada under Part I.

• The amount of the benefit would have been included in the taxpayer's income if it had

been a payment made directly to the taxpayer.

• The taxpayer is resident in Canada.

If these conditions are met, the benefit is included in the taxpayer's income or taxable income

earned in Canada under Part I in the taxation year in which the benefit is conferred. If the

taxpayer is a non-resident, the amount of the benefit shall be deemed, for purposes of Part XIII,

to be a payment made to the taxpayer in respect of property, services, or otherwise depending on

the nature of the benefit.

Subsections 246(1) and 56(2) are directing provisions; the first applies to the recipient of the

benefit and the last to the person conferring the benefit.

If subsection 56(2) does not apply, read the rules in subsection 15(1) together with the anti-

avoidance provisions of subsections 246(1) and (2), insofar as they relate to indirect payments or

transfers made by a corporation for the benefit of a shareholder or as a benefit that the

shareholder desired to have conferred on some other person.

Note, however, that subsection 246(1) will not apply if subsection 246(2) applies. Subsection

246(2) states that if persons dealing at arm's length enter into a bona fide transaction and the

transaction is not according to, or part of, any other transaction, and is not to effect payment, in

whole or in part, of an existing or future obligation, a benefit will not be regarded as having been

conferred by either party to the transaction.

Example

Facts

Spud Ltd. is a wholly-owned subsidiary of Potato Corp. The sole shareholder of Potato Corp. is

Mr. Chips. In 2013, Spud Ltd. purchased a cottage in Christina Lake, B.C. for $480,000.

Mr. Chips and his family use the cottage during the summer months and occasionally during the

winter months for free. A cottage in this area normally rents for $4,300 per month.

Effect of subsection 246(1) of the ITA

Subsection 15(1) does not apply to the conferral of benefits to the indirect shareholder.

Consequently, depending on the circumstances, supplement subsection 15(1) and read together

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Published May 2015

with either the provisions in subsection 56(2) or subsection 246(1). However, subsection 56(2)

cannot apply to the calculation of shareholder benefits as the “use of property” made available by

the shareholder (Potato Corp.) to some other person who is not a shareholder of the corporation

(Mr. Chips), is not considered to be a "payment or transfer of property" unless there is a lease,

sale, or gift that has been transferred.

As a result, subsection 246(1) would apply to include a benefit, according to subsection 15(1), in

Mr. Chips' income. If Mr. Chips had received the benefit directly, subsection 15(1) would have

applied to include the amount of the benefit in his income.

24.11.4 References


Court cases relating to subsection 56(2) of the ITA

Benefit amount

• Winter et al. v. The Queen, 1990 (FCA) 90 DTC 6681

Attribution of the proceeds of distribution

• Sunroot Energy Ltd. v. The Queen, 1997 (TCC) 97 DTC 1435

Benefit conferred on a trustee

• The Galway Family Trust v. MNR, 90 DTC 1913

Commissions paid to related corporations

• Minet Inc. v. The Queen, 1998 (FCA) 98 DTC 6364

Desire to confer a benefit

• Jones et al. v. The Queen, 1996 (FCA) 96 DTC 6015

Dividends paid to shareholders

• Nelson v. The Queen, 1974 (FCA) 74 DTC 6266

Dividends paid to spouses or common-law partners

• Champ v. The Queen, 1983 (FCTD) 83 DTC 5029

• The Queen v. McClurg, 1991 (SCC) 91 DTC 5001

• Neuman v. MNR, 1998 (SCC) 98 DTC 6297

• Rao v. MNR, 1999 (TCC) 99 DTC 413

Transfer of commissions

• McClain Industries of Canada Inc. (Formerly Maple Leaf Metal Products Ltd.) v. The

Queen, 1978 (FCTD) 78 DTC 6356

Transfer of a call option

• Gilvesy v. The Queen, 1996 (TCC) 96 DTC 1417

Transfer of salary

• The Queen v. Campbell, 1980 (SCC) 80 DTC 6239

35

Published May 2015

Subrogation of debtor

• MNR v. Bisson, 1972 (FCTD) 72 DTC 6374

Contributions paid by third parties

• The Queen v. MacIntyre, 1975 (FCA) 75 DTC 5240

Payments to a management company

• Campeau et al. v. MNR, 70 DTC 6223

• MNR v. Cameron, 1972 (SCC) 72 DTC 6325

Estate settlement

• Cox v. The Queen, 1982 (FCTD) 82 DTC 6287]

Business income converted to a capital gain

• Ledoux v. The Queen, 98 DTC 1034

Diversion of funds among companies

• Smith v. The Queen, 1993, (FCA) 93 DTC 5351

• Lamontagne et al. v. The Queen, 98 DTC 6226

Training product

• TD1018-000, Transactions between a Corporation and its Shareholders


• IT335R2, Indirect payments, at www.cra-arc.gc.ca/E/pub/tp/it335r2/README.html

• IT432R2, Benefits conferred on shareholders, at www.cra-


• IT419R2, Meaning of arm's length, at www.cra-


24.12.0 Shareholder debt



This subchapter deals with the tax treatment of shareholder loans and indebtedness.

In 1949 the Supreme Court of Canada, in T. E. McCool 49 DTC 700, held that a loan and

indebtedness were not the same. The court stated that a loan required the existence of a

lender/borrower relationship, while indebtedness, the existence of a creditor/debtor relationship.

The court quoted Black's Law Dictionary in defining a loan as "Delivery by one party to and

receipt by another party of a sum of money upon agreement, express or implied, to repay it with

or without interest." (Note: The term loan is not restricted to a loan of money. The CRA

recognizes loans of property such as gold and stock.)

The court clarified that indebtedness was simply a sum of money owing from one person to

another and that a debt could arise under a contract without the existence of a loan. For example,

if a purchaser of property fails to pay the purchase price. Examples of indebtedness include the







36

Published May 2015

unpaid purchase price of property, unpaid rent and interest (whether or not it is in respect of a

loan), and trade accounts receivable.

24.12.2 Subsection 15(2) of the ITA - Shareholder debt


The purpose of this section is to provide an overview of subsection 15(2). For detailed

information, refer to Income Tax Interpretation Bulletin IT119R4, Debts of shareholders and

certain persons connected with shareholders, at www.cra-

arc.gc.ca/E/pub/tp/it119r4/README.html. The bulletin discusses the tax implications to a

person or partnership who is a shareholder of a corporation, connected with a shareholder of a

corporation, or who owns shares of the corporation through a partnership or trust, regarding a

loan or indebtedness from that corporation, a related corporation or a partnership of which that

corporation or a related corporation is a member.

Subsection 15(2) generally requires a shareholder to include in income the amount of any loan

received or indebtedness incurred from a corporation in a taxation year, unless the loan or

indebtedness (or part thereof) is specifically excluded. The purpose of this provision is to prevent

dividends from being paid out in the guise of loans or other indebtedness.

Subsection 15(2) does not apply to corporations resident in Canada or to partnerships, each

member of which is a corporation resident in Canada. The borrower may be a non-resident

corporation.

Once the auditor has determined that a transaction meets the conditions in subsection 15(2), the

auditor must ensure that the loan is not excluded by any one of the exceptions set out in

subsections 15(2.2) to (2.6).

Subsection 15(2) does not apply:

1. Subsection 15(2.2) - non-resident persons - if the indebtedness is between non-resident

persons.

2. Subsection 15(2.3) - ordinary lending business - if 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, and bona fide arrangements were made at the time the loan was made

for repayment within a reasonable time.

3. Subsection 15(2.4) - certain employees - if the borrowers are also employees of the

lender and only if a specific loan was made for a qualified purpose described in

paragraphs 15(2.4)(b) to (d). These loans are excluded if the shareholder is also an

employee:

• A loan made to an individual who is an employee of the lender but not a specified

employee of the lender. A specified employee is an employee who does not deal

at arm's length with the lender or who owns directly or indirectly at least 10% of

the shares of a given class of capital stock of the corporation or of a corporation

related to it.

• A loan made to an individual who is an employee of the lender or is the spouse or

common-law partner of an employee of the lender to acquire a dwelling or a share

of the capital stock of a co-operative housing corporation acquired for the sole

purpose of inhabiting one of the units.



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Published May 2015

• A loan made to an employee to acquire previously unissued fully paid shares of

that corporation or a corporation related to it.

• A loan made to an employee to acquire a motor vehicle to be used in the

performance of the employee's job.

The exceptions in subsection 15(2.4) are subject to the requirements that the employee or

the employee's spouse or common-law partner received the loan because of the

employee's employment and not because of any person's shareholdings and at the time

the loan was made, bona fide arrangements were made for repayment of the loan within a

reasonable time.

4. Subsection 15(2.5) - certain trusts - to a loan regarding a trust if the conditions described

in subsection 15(2.5) are met. The conditions involve facilitating the purchase and sale of

shares of this or a related corporation, by or from employees.

5. Subsection 15(2.6) - repayment within one year - to a loan that 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.

A taxpayer may be subject to a taxable interest benefit calculated under section 80.4 regarding

any loan or part thereof that has not been included in income under subsection 15(2) as long as

an amount remains outstanding.

As stated in paragraph 38 of Income Tax Interpretation Bulletin IT119R4, Debts of shareholders

and certain persons connected with shareholders, at www.cra-

arc.gc.ca/E/pub/tp/it119r4/README.html, 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. A dividend paid by a corporation resident in Canada to a

non-resident is subject to income tax under subsection 212(2) and the lender must withhold and

remit the tax to the Receiver General.

Bona fide repayment arrangements

The CRA's main concern with respect to shareholder loans is that bona fide arrangements were

made, at the time of the loan, for repayment of the loan within a reasonable time. Whether the

period allowed for repayment is "within a reasonable time" is a question of fact. In a given

situation, one of the factors the CRA will consider is what would happen in a normal commercial

practice. For instance, if an employee-shareholder of a financial institution receives the use of a

low-interest or interest-free credit card, the CRA will look to what is commercially acceptable

with respect to the particular debt in determining whether the repayment arrangements are bona

fide.

It would be reasonable to conclude that an interest-free loan is not a bona fide arrangement

according to normal commercial practices. However, since section 80.4 specifically provides for

the calculation of an interest benefit, the CRA has taken the view that an interest-free loan does

not actually mean that a bona fide arrangement was not made.

A demand loan is not considered a bona fide arrangement for repayment. A demand loan is

open-ended and does not specify when the debtor must make the payment.



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Published May 2015

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.

A loan need not be repaid in cash. A payment of property is acceptable. Whenever a payment is

made with property other than cash, the amount of the payment will be equal to the property's

FMV at the time of the transfer to the lender.

Dividends, bonuses, and salaries may be credited to a shareholder loan account and constitute

payment to the extent that such amounts reduce the loan balance outstanding. A payment of

employment income in this manner is considered to be received (the doctrine of constructive

receipt) and is included in the borrower's income in the taxation year in which the amount is

credited. Withholdings may also be required.

These court cases deal with various aspects of bona fide repayment arrangements:

Decision/Issue Court Case

A simple corporate resolution, by itself, to

establish appropriate repayment obligations

was not considered bona fide.

Deckelbaum v. MNR, 1982 (TRB)

82 DTC 1636

An oral agreement to repay within three to

four years was not considered bona fide.

Hendriks v. MNR, 1981 (TRB) 81 DTC 939

The absence of written evidence was

considered fatal.

Wright v. MNR, 1986 (TCC) 86 DTC 1415

Repayment arrangements must be made when

the loan was made or the indebtedness arose.

Reekie v. MNR, 1980 (TRB) 80 DTC 1447

A demand loan is not considered a bona fide

repayment arrangement.

Lavoie v. The Queen, 1995 (TCC)

95 DTC 673

Source of funds Kalousdian v. The Queen, 1994 (TCC)

94 DTC 1722

Is a promise to repay sometime within a

five-year period acceptable?

Davidson v. The Queen, 1999 (TCC)

99 DTC 933

Does a failure to repay a loan mean that it no

longer complies with the bona fide

arrangements requirement?

Hnatuk et al. v. The Queen, 1997 (TCC)

97 DTC 674

Is a promissory note given for a housing loan

acceptable if there are no predetermined

repayments?

Dionne Jr. et al. V. The Queen, 1998 (TCC)

98 DTC 1245

Are there arrangements for repayment within

a reasonable period if a housing loan made to

a shareholder/employee is only payable on

termination of employment?

The Queen v. Silden, 1993 (FCA)

93 DTC 5362

39

Published May 2015

Series of loans or other transactions and repayments

As mentioned earlier, 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, the loan is not included in the

income of the borrower under subsection 15(2).

A series is generally restricted to a repayment 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 is of a temporary nature and is not considered to decrease the loan balance in applying

subsection 15(2).

Running loan accounts are not automatically considered a series and all of the relevant factors

need to be considered to determine whether a series of loans or other transactions and

repayments exists. Bona fide repayments of shareholder loans that result from the payment of

dividends, bonuses, or salaries are not considered part of a series of loans or other transactions

and repayments. Repayments are generally applied to the oldest outstanding loan or debt first

(first in, first out (FIFO) basis) and not according to the last in, last out (LIFO) principle.

The following are significant court decisions dealing with bona fide repayments of shareholder

loan accounts that are not part of a series of loans and repayments:

• Attis v. MNR, 1992 (TCC) 92 DTC 1128

• Uphill Holdings Ltd. et al. v. MNR, 1993 (TCC) 93 DTC 148

For more information, go to paragraphs 27, 28, and 29 of Income Tax Interpretation Bulletin

IT119R4, Debts of shareholders and certain persons connected with shareholders, at www.cra-

arc.gc.ca/E/pub/tp/it119r4/README.html.

Dealing with what constitutes a series of loan and repayments, go to Tax and Charities Appeals

Directorate (TCAD) Decision Details:

• ITC-93-009

• ITC-93-009R

• ITC-93-009R2

24.12.3 Repayment of loan by shareholder


Paragraph 20(1)(j) permits a deduction on the repayment of any loan or indebtedness by the

shareholder which was previously included in income under subsection 15(2). The deduction is

allowed for the taxation year a repayment is made if it is not part of a series of loans or other

transactions and repayments.

Before December 22, 1992, a non-resident taxpayer repaying a loan previously deemed to be a

dividend under paragraph 214(3)(a) was not allowed a paragraph 20(1)(j) deduction because the

loan was not included in income under subsection 15(2). Subsection 227(6.1) provides for a

refund of the Part XIII tax paid on a loan deemed to be a dividend if the person, on whose behalf

the tax was paid, repays the loan after December 21, 1992. For more information, go to Income

Tax Interpretation Bulletin IT119R4, Debts of shareholders and certain persons connected with

shareholders, paragraph 39, at www.cra-arc.gc.ca/E/pub/tp/it119r4/README.html.




http://sh0zapdb0393:8500/Production/WBA039/index.cfm?event=1_2_p&Product_type=ITC_decisions&Product_number=93009R_1&lang=fre%20%5b*link

http://sh0zapdb0393:8500/Production/WBA039/index.cfm?event=1_2_p&Product_type=ITC_decisions&Product_number=93009R2_1&lang=eng


40

Published May 2015

As indicated in Income Tax Interpretation Bulletin IT119R4 (paragraph 33), paragraph 20(1)(j)

applies to a partnership if a loan has been included in calculating the income of the partnership in

a preceding year and the partnership subsequently repays the loan.

24.12.4 Subsection 15(2) of the ITA - Audit issues


Subsection 15(2) will not apply unless it is clear that there is a loan. 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 audit evidence that a loan exists. Such audit

evidence could include a corporate resolution setting out the loan and the terms of its repayment.

The audit steps required to determine whether a taxpayer is subject to subsection 15(2) may be

recorded on these audit working papers:

• Reconciliation, Monthly balance computation, and Analysis of credits;

• Indebtedness income analysis (subsection 15(2) and paragraph 20(1)(j)); and

• Interest benefit calculation (section 80.4).

Reconciliation, Monthly balance computation, and Analysis of credits

The auditor:

• reconciles the shareholder's account to the balance on the financial statements for each

fiscal period under audit;

• segregates the shareholder account transactions into debits (loans) and credits

(repayments), according to the legislation; this requires separate consideration of each

loan or indebtedness, which is different from the CRA's former practice of netting loans

against repayments in a given year;

• separates the transactions into the months they occurred; for example, when accountants

make one year-end entry to account for all of the shareholder's transactions during the

year, allocate these amounts to the actual month they occurred - this allows the monthly

balances to be computed for the purpose of calculating a section 80.4 interest benefit if

applicable;

• segregates the loans that have specific repayment terms from the shareholder's account

and analyze their tax implications separately;

• asks the shareholder how the repayments were to be applied; for example, was the intent

to have the repayments apply to specific debts?

This working paper can also be used to record the auditor's analysis of credits to the

shareholder's account for the purpose of determining whether there are any benefits subject to

subsection 15(1) or the existence of income such as dividends, interest, employment earnings, or

rent.

Because of the one-year repayment period set out in subsection 15(2.6), a loan or debt incurred

in the latest taxation may require a historic review of all related transactions.

Indebtedness income analysis (Subsection 15(2) and Paragraph 20(1)(j))

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Published May 2015

Remove any incorrect as well as the subsequent correcting entries to the shareholder's loan

account.

For example, the shareholder's loan account was in a $1,088,363 debit balance near the end of

the fiscal period when it was credited as follows:

• 2013-JUN-30 AJE #9 Due from related company $1,200,000

Shareholder's loan $1,200,000

To record the transfer of an account receivable from a related company.

• 2013-JUL-31 AJE #1 Shareholder's loan $1,200,000

Due from related company $1,200,000

To record the reversal of AJE #9, which was an incorrect posting.

In determining the amount of repayments during the fiscal period ending June 30, 2013, the

$1,200,000 credit must be excluded, because it was not a repayment but rather an error.

The auditor:

• analyzes the remaining debits in each fiscal year of the company to determine whether

those amounts were repaid before the end of the following fiscal year end;

• applies repayments that arise in a given fiscal period to the oldest outstanding

indebtedness of the shareholder (that is, the FIFO basis), unless the facts clearly indicate

otherwise;

• does not consider any repayment that is part of a series of loans and repayments in

determining whether a specific loan has been repaid in time.

Any repayment of indebtedness that was included in income under subsection 15(2) is deductible

in the year of repayment in accordance with paragraph 20(1)(j).

Interest benefit calculation (Section 80.4 of the ITA)

Calculate an interest benefit on any outstanding indebtedness that has not been subject to

subsection 15(2), including any indebtedness that should have been but was not assessed because

the applicable taxation year was statute-barred. Subsections 80.4(1) and (2) do not apply in

respect of any loan or debt, or any part thereof, that was included in computing the income of a

person or partnership under Part I.

Calculate the interest benefit using the prescribed rates in Regulation 4301 and the month-end

balances in the account. Using month-end balances would not usually result in a material

difference from using daily balances, but if there are significant fluctuations in the account

balance between month ends, consider using the daily balances.

For more information about section 80.4, go to 24.12.4.

Example illustrating subsection 15(2) concepts

Facts

An audit of A Ltd., a Canadian-controlled private corporation (CCPC), indicated that a number

of shareholder loans were made in 2010. A Ltd has a December 31 year-end.

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Published May 2015

All of the shareholders are resident in Canada and deal at arm's length with A Ltd. None of the

shareholders had received loans prior to 2010. Since A Ltd. was not in the business of lending

money, it was very careful, in each case, to ensure that bona fide arrangements were made at the

time the loan was made for repayment within a reasonable time.

Taking all of this into consideration, which of the following loans will be included in the

borrower's income under subsection 15(2) in 2010?

A. A loan to Ms. A, a vice-president and 20% Class A shareholder. The loan was made to

assist her in the purchase of previously unissued shares of A Ltd. The loan was made on

February 14, 2010, and repaid in full exactly one year later. This type of loan is

unavailable to any other employees.

B. A loan was made to B Ltd., a corporation that owns 25% of the Class A shares of A Ltd.

The loan was used to reacquire some of its own shares for cancellation and to repay a

bank loan.

C. A loan to Ms. L, a corporate executive and 15% owner of Class B shares of A Ltd.

This loan was made to assist her in the purchase of a home. The loan was made on

July 2, 2010, and repaid, in full according to an early repayment clause in the mortgage,

on September 29, 2012. Such loans are unavailable to any other employees.

D. A loan to Mr. R, the treasurer and 8% shareholder of Class A shares of A Ltd. The loan

was used to assist him in acquiring a home computer for employment purposes. Five

other employees (none of whom are shareholders) are currently working at home and

have received similar loans. The loan was made to Mr. R on March 12, 2010, and fully

repaid by May 19, 2013.

E. The same as "D" except for these new facts:

1) Mr. R owns 11% of the Class A shares, and

2) none of the exceptions listed in subsections 15(2.3) and (2.4) apply.

Comments

A. The loan is not included in income under subsection 15(2) by virtue of subsection 15(2.6)

because it is repaid by the end of the year (that is, by December 31, 2011) of the lender

immediately following the year in which the loan was made.

This loan does not meet any of the exceptions in subsections 15(2.2) through (2.5). The

minority shareholder rule set out in paragraph 15(2.4)(a) would not apply, since Ms. A is

a specified employee because she owns more than 10% of one class of shares of the

corporation. Paragraph 15(2.4)(c) is not applicable because the facts indicate that the

employment capacity test in paragraph 15(2.4)(e) cannot be met because the loan is

unavailable to other employees.

An imputed interest benefit under subsection 80.4(2) (shareholder capacity) would apply

to the period in the year in which the loan remained outstanding.

B. The loan would not be included in the income of B Ltd., because subsection 15(2) does

not apply to borrowers that are corporate shareholders resident in Canada. Also,

subsection 80.4(2) would not apply for the same reason.

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Published May 2015

C. The principal amount of the loan outstanding on December 31, 2011, will be included in

Ms. L's 2010 income under subsection 15(2) because it was received in her capacity as a

shareholder. Such a loan would be excluded from Ms. L's income under subsection 15(2)

by virtue of paragraph 15(2.4)(b) if the loan had been received in an employment

capacity. The facts indicate that it was received by virtue of shareholdings and, therefore,

could not meet the condition in paragraph 15(2.4)(e). The repayment in the year 2012

will result in a tax deduction under paragraph 20(1)(j) in that year.

The loan could also have been excluded by subsection 15(2.6) if it had been repaid in full

by December 31, 2011. Furthermore, subsection 80.4(2) will apply to impute an interest

benefit with respect to any loan principal repaid before January 1, 2012. Such benefit will

be calculated for the period such amounts are outstanding.

D. Mr. R will not have to include any amount with respect to the computer loan in his

income under subsection 15(2). Although there is no specific mention of a loan to acquire

a computer, paragraph 15(2.4)(a) allows any loan to a shareholder who is not a "specified

employee" (defined in subsection 248(1)) to be excluded as long as bona fide

arrangements for repayment are made and the loan is received in an employment capacity

(paragraphs 15(2.4)(e) and (f). A specified employee is an employee who is either a

specified shareholder (that is, generally, a person who holds at least 10% of the shares of

any class of the corporation at any time in the year) or a person who does not deal at

arm's length with the corporation. Since Mr. R owns less than 10% of the shares of a

class and deals at arm's length, he is not a specified employee. Subsection 80.4(1) will

however apply to impute an interest benefit for the period of time during which the loan

balance is outstanding.

E. The 11% shareholding in a class of shares means that Mr. R is a "specified employee" as

defined in subsection 248(1). This prevents him from using the minority shareholder

exception in paragraph 15(2.4)(a) to exclude the loan from subsection 15(2). In addition,

the purchase of a computer is not one of the specified purposes in paragraphs 15(2.4)(b)

to (d) that would exempt the loan.

The loan is excluded if it is repaid within the time frame in subsection 15(2.6). The

portion of the loan repaid before January 1, 2012, will be excluded from subsection

15(2), but will be subject to the application of section 80.4 based on the number of days

that part of the loan was outstanding. The balance of the loan outstanding on

January 1, 2012, will be subject to subsection 15(2) in Mr. R's 2010 taxation year.

Repayments after 2011 will be deductible under paragraph 20(1)(j) in the taxation year in

which the repayment is made.

Application of subsection 15(2) and paragraph 20(1)(j) of the ITA when a "series"

As indicated in paragraph 34 Income Tax Interpretation Bulletin IT119R4, Debts of shareholders

and certain persons connected with shareholders, at www.cra-

arc.gc.ca/E/pub/tp/it119r4/README.html, when there is a series of loans or other transactions

and repayments, 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 under subsection 15(2)

without allowing the one year for repayment, unless they come within one of the other excepting

provisions of subsections 15(2.3) to (2.5).



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Published May 2015

Refer to the example in paragraph 36 of Income Tax Interpretation Bulletin IT119R4, which

illustrates the analyses of a shareholder's loan account 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.

24.12.5 Section 80.4 of the ITA - Benefit on interest-free or low-interest loans


This section of the Income Tax Audit Manual discusses the taxation of benefits arising from

certain interest-free or low-interest loans or debts. Section 80.4 sets out a formula and various

other rules for the calculation and inclusion in income of taxable benefits that may be deemed to

have been received as a result of receiving loans or incurring debts that bear less than a

prescribed rate of interest. Subject to certain exceptions, these deemed benefit provisions are

applicable if the loan or debt is received by virtue of an office or employment of an individual,

by virtue of the services provided by the personal services business of a corporation, or by virtue

of shareholdings in a corporation.

Read this section together with Income Tax Interpretation Bulletin IT421R2, Benefits to

individuals, corporations, and shareholders from loans or debt, at www.cra-


Capacity in which a person receives a loan

Subsection 80.4 is divided into two main subsections that present not only different calculations,

but also may impose tax liability on different persons, depending upon the circumstances. The

capacity in which a person receives a loan will determine the subsection that will apply.

Accordingly, subsection 80.4(1) applies when a loan is received in an employment capacity. It

applies to individual employees or to an incorporated employee (a corporation carrying on a

personal services business).

Subsection 80.4(2) applies when a loan is received in a shareholder capacity. This provision

specifically applies to persons or partnerships excluding resident Canadian corporations or

partnerships composed solely of such corporations.

Loans received in any other capacity are not subject to section 80.4.

Subsections 80.4(1) and (2) will continue to apply to outstanding loans or indebtedness, even if

the employee ceases to be an employee and the shareholder ceases to be a shareholder. The test

of capacity occurs at the time that the loan is made. A person or partnership is considered to have

received a loan or incurred a debt when the funds are advanced or the relevant documents are

executed and the person or partnership becomes legally obligated to repay the loan or discharge

the debt.

Employee benefit – Subsection 80.4(1)

Subsection 80.4(1) applies when:

• a loan is received from an employer because of an employee's current employment;

• a person or a partnership, which is not an employee, receives a loan from a lender

because of the employment of an individual; for example, an employer can make a loan

to the spouse or common-law partner of an employee, the spouse or common-law partner



45

Published May 2015

is the person who received the loan, and the employee is the individual by virtue of

whom the loan was made;

• a loan is made to an individual who is both an employee and a shareholder of the

employer (lender), only if the loan was made in a capacity of an employee.

Subsection 80.4(1) only states that the loan must relate to employment. In the situations

described above, the lender is also the employer of the individual by virtue of whom the loan is

made. However, it is important to note that subsection 80.4(1) may apply even if the lender is not

the employer.

If an employer helps an employee to obtain a loan, for instance, by providing support for the

employee's loan application, the loan will be considered to have been received by virtue of

employment. If the employee obtains a loan without the help of the employer, any assistance by

the employer to subsidize the interest costs of the employee will not cause the loan to be received

by virtue of office or employment. The interest subsidy will however be included in the

employee's income under subsection 6(1)(a).

Calculation of the benefit – Subsection 80.4(1)

Paragraph 80.4(1)(a) applies in respect of the balance of all loans outstanding at any time in the

taxation year of an individual or a corporation which carries on a personal services business in a

taxation year. A separate calculation is not made under subsection 80.4(1) for each loan; rather

the interest benefit is aggregated for all such loans.

The amount under paragraph 80.4(1)(a) is the deemed interest calculated at the prescribed rates

in effect for the period during the year in which the loan is outstanding. Interest is calculated for

each day the loan is outstanding. It is not necessary that the loan remain unpaid at the end of the

year of the borrower for a benefit to be calculated. If the loan is repaid in the year, the benefit is

calculated on the number of days that the loan was outstanding in that year.

Paragraph 80.4(1)(b) provides for an addition to the interest benefit amount when interest on the

loan is paid or payable with respect to the year by certain third parties on behalf of the borrower.

Therefore, such interest will be added to the calculation of the interest benefit if it is paid or

payable by any of the following persons:

• the employer or intended employer of the individual by virtue of whom the loan or debt

was made; for example, when the employer is not the lender, but pays interest or agrees

to pay interest to the lender;

• any person related to the employer; for example, were it not for this subparagraph, a

benefit could be avoided by having a corporate employer make a loan to an employee and

have the interest paid by a related corporation; or

• a person or a partnership, which is, or will be, the recipient of services performed by a

corporation carrying on a personal services business; here we refer to the employer of the

incorporated employee or to a person (other than the borrower) who is not dealing at

arm’s-length with this person or a member of the partnership.

Paragraph 80.4(1)(c) provides that the benefit calculated for a person or partnership will be

reduced by the amount of any interest paid in respect of any such loans in the year or within 30

days thereafter, regardless of the identity of the payer. Accrued interest at year-end is not

considered, unless it is paid within the 30-day period.

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Published May 2015

Paragraph 80.4(1)(d) reduces the benefit calculation if the borrower reimburses, in the year or

within 30 days thereafter, any portion of the interest the person or entity described in paragraph

80.4(1)(b) had paid on the loan.

Subsection 80.4(7) defines, for the purpose of section 80.4, the "prescribed rate." The reference

to “prescribed” refers to section 4301 of the Regulations.

Shareholder benefit – Subsection 80.4(2)

Subsection 80.4(2) applies when a loan is received by a person or a partnership described in the

subsection in the capacity of a shareholder. The benefit under subsection 80.4(2) is deemed to be

received by the person or the partnership who received the loan or debt and not by the

shareholder by virtue of whom the loan or debt was made.

For example, a loan is made to the spouse or common-law partner of a shareholder and by virtue

of that person's shareholdings. The spouse or common-law partner, not the shareholder, will be

required to include the imputed interest benefit in income.

Calculation of the benefit – Subsection 80.4(2)

The benefit is calculated as the difference between paragraphs 80.4(2)(d) and (e) for each

taxation year in which the loan remains outstanding.

Paragraph 80.4(2)(d) applies in respect of all loans of the person or partnership which are

outstanding at any time in a taxation year. If a person or partnership has received two or more

loans that were outstanding in the taxation year, the interest benefit will be determined by

totalling the interest benefits for all such loans.

The calculation of the paragraph 80.4(2)(d) amount consists of applying the prescribed rates

(section 4301 of the Regulations) on a daily basis to the outstanding loan balance.

It is not necessary that a loan balance remain outstanding at the end of the year for a benefit to be

calculated. If the loan or debt is repaid in full before the year-end, the benefit is calculated for the

number of days in the year during which the loan was outstanding.

Paragraph 80.4(2)(e) applies to reduce the amount of the benefit by the amount of interest paid

on all such loans in the year or within 30 days thereafter by any party. Interest payable at year-

end does not reduce the interest benefit, unless such amounts are actually paid within 30 days

after that year-end.

If a corporation pays the interest on a loan on behalf of one of its shareholders, the amount of

interest paid will be considered in the calculation in paragraph 80.4(2)(e).

This could occur if a shareholder received a loan from a related corporation and the corporation

in which he or she owns shares pays any part of the interest. In such cases, the payment of

interest by the corporation reduces the interest benefit to the shareholder under paragraph

80.4(2)(e). However, a benefit of an equal amount arises under subsection 15(1), since the

corporation has provided the shareholder a benefit by paying the debt.

Exceptions set out in subsection 80.4(3)

Subsection 80.4(3) provides exceptions to the rules set out in subsections 80.4(1) and (2).

Paragraph 80.4(3)(a) provides that a benefit will not arise if the rate of interest payable on the

47

Published May 2015

debt is equal to or greater than the rate of interest that would have been agreed upon in an arm's

length transaction at the time the obligation was incurred.

There are two assumptions to consider:

1. none of the parties received the loan because of an employment or shareholder capacity;

and

2. the ordinary business of the lender included lending money.

However, this exception will not apply if a party other than the debtor pays any interest on the

debt to the creditor, even if the interest was negotiated at normal commercial rates.

For example, on August 30, 2013, an individual obtains a $100,000 loan at 8% interest from a

corporate employer. Assume that the loan meets the requirements of paragraph 80.4(3)(a).

Therefore, no imputed interest benefit will apply under section 80.4. If in 2014 a related

corporation agrees to pay one-quarter of the interest (2%), then section 80.4 will apply in that

year. A benefit will only be determined, however, if the prescribed rate exceeds 6% (the net

amount that the individual is required to pay).

As stated in paragraph 10 of Income Tax Interpretation Bulletin IT421R2, Benefits to


arc.gc.ca/E/pub/tp/it421r2/README.html, paragraph 80.4(3)(b) provides that subsections

80.4(1) and (2) do not apply if another provision of Part I of the ITA brings the loan or debt into

the income of the debtor. For example, neither subsection 80.4(1) nor (2) apply if subsection

15(2) has already brought the loan or debt into the taxpayer's income. An assessment under

subsection 15(2) is not precluded, even if the taxpayer has voluntarily reported a benefit under

section 80.4. Subsection 15(2) has priority over section 80.4.

Loans to shareholder-employees

As indicated in Income Tax Interpretation Bulletin IT421R2, at www.cra-

arc.gc.ca/E/pub/tp/it421r2/README.html, the capacity in which a person or partnership

receives a loan is significant because that capacity determines whether any benefit is to be

computed under subsection 80.4(1), as a result of an office or employment or under 80.4(2), as a

result of shareholdings. If a person is both an employee and a shareholder, it is a question of fact

whether a loan arose as a result of the person's shareholdings or as result of the office or

employment. For more information regarding benefits arising by virtue of shareholdings, go to

Income Tax Interpretation Bulletin IT421R2 paragraphs 6 and 7.

Once a loan or other indebtedness becomes subject to the provisions of section 80.4, it remains

subject to those provisions for all taxation years until fully repaid. Therefore, a loan obtained by

reason of shareholdings can continue to be subject to section 80.4, even if the recipient of the

loan is no longer a shareholder.

Income Tax Interpretation Bulletin IT421R2 paragraph 9, at www.cra-

arc.gc.ca/E/pub/tp/it421r2/README.html, states that a benefit, calculated under the provisions

of section 80.4, is brought into the income of an individual, partnership, corporation, or

shareholder, as the case may be, according to these provisions:

a) subsection 80.4(1) benefits:

• under subsection 6(9) in the case of an individual;







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Published May 2015

• under paragraph 12(1)(w) in the case of a corporation that carries on a personal

services business as described in paragraph 125(7)(d); and

• under subsection 15(9) in the case of a person or partnership, if subsection 6(9) or

paragraph 12(1)(w) does not require the amount to be included in income.

b) subsection 80.4(2) benefits, under subsection 15(9).

Deductibility of interest assessed under section 80.4

Section 80.5 provides that if a benefit is included in the income of a taxpayer under section 80.4

in respect of employee or shareholder debt, the amount of the benefit is deemed to be interest

paid in the year according to a legal obligation with respect to borrowed money for purposes of

the rules in subparagraph 8(1)(j)(i) and paragraph 20(1)(c). Therefore, if the borrowed funds are

used to earn income from business or property, the amount of the interest may be deductible in

computing the income of the taxpayer.

Under subparagraph 8(1)(j)(i), employees are permitted to deduct interest on funds borrowed to

buy a motor vehicle or aircraft if they are eligible to deduct expenses under either the salesmen's

or travel expense provisions, that is paragraphs 8(1)(f), (h), or (h.1). Therefore, if a benefit is

included in the income of an employee under section 80.4 and the borrowed funds are used to

acquire a motor vehicle or aircraft, the employee is allowed to treat the section 80.4 benefit as

interest expense under subparagraph 8(1)(j)(i).

Non-residents

Non-resident tax under subsection 212(2) may apply if a corporation resident in Canada makes a

loan to a shareholder, or to any other person or partnership described in subsection 80.4(2). In

such cases, any benefit deemed to have been received under subsection 80.4(2) which would be

included in the recipient's income for the year under subsection 15(9) if the recipient were

resident in Canada, will, by virtue of paragraph 214(3)(a), be subject to non-resident tax under

subsection 212(2) for any taxation year in which the recipient is a non-resident.

If a non-resident is employed in Canada and received a loan or otherwise incurred a debt by

virtue of that employment, any benefit deemed received under subsection 80.4(1) is included in

computing the non-resident's taxable income earned in Canada by virtue of subsections 2(3),

6(9), and 115(1).

24.12.6 Subsection 80.4(2) of the ITA - Audit issues


Whether subsection 80.4(1) or 80.4(2) applies

It is important to determine if subsection 80.4(1) or 80.4(2) apply to a loan received by an

employee-shareholder because:

• the benefit is calculated differently;

• source deductions apply to interest benefits taxable under subsection 6(9), but not to

benefits taxable under subsection 15(9);

• if subsection 80.4(1) applies, the benefit is taxable in the hands of the employee, even if a

third party, such as the employee's spouse or common-law partner, may be the real debtor

49

Published May 2015

or beneficiary of the loan; however, benefits under subsection 80.4(2)] are taxable only in

the hands of the debtor;

• a loan obtained by a person as a shareholder cannot be characterized as a home purchase

or relocation loan under subsection 80.4(4); and

• the deductibility of the interest deemed paid under section 80.5 may vary.

The CRA's assessment policy regarding section 80.4, subsection 15(2.6), and

paragraph 20(1)(j)

The CRA's revised position on assessments, from November 22, 1994, gives more importance to

section 80.4 than to subsection 15(2.6) and paragraph 20(1)(j). The new policy is:

• Loan repayments are applied on a FIFO instead of on a LIFO basis, unless the facts

clearly indicate otherwise (go to paragraph 27 of Income Tax Interpretation Bulletin

IT119R4, Debts of shareholders and certain persons connected with shareholders, at

www.cra-arc.gc.ca/E/pub/tp/it119r4/README.html).

• Running loan accounts are not automatically considered a series of loans and repayments.

Determining whether a series exists depends on relevant factors set out in case law (go

to paragraphs 28 and 29 of Income Tax Interpretation Bulletin IT119R4).

For more information, go to Tax & Charities Appeals Directorate (TCAD) Decision Details

ITC-93-009R, dealing with the CRA's position concerning what constitutes a series of loans and

repayments.

Example

Suppose you audit an individual in May 2014 for the 2012 and 2013 taxation years. The

individual is a shareholder of a corporation whose fiscal period ends June 30. In May 2012, the

taxpayer borrowed $40,000 from the corporation, and, in September 2012, an additional $60,000.

You conclude that none of the exceptions in subsections 15(2.3) or (2.4) apply. The loans were

not repaid before the audit, and there is no indication the loans will be repaid in the near future.

Under subsection 15(2.6), the individual has until June 30, 2013, to repay the $40,000 loan and

until June 30, 2014, to repay the loan of $60,000.

However, our policy says that the interest benefit be calculated under section 80.4 for 2012

without waiting for the one-year repayment period per subsection 15(2.6) and code the file for a

follow-up audit. If during the follow up audit, it is determined that the loan is taxable under

subsection 15(2), a reassessment will be issued to delete the 80.4 benefit and tax the shareholder

under subsection 15(2).

Interrelationship of subsection 15(2) and section 80.4

Paragraph 80.4(3)(b) provides that no benefit will be assessed under section 80.4 in respect of

any amount included in income under Part I. For this reason, subsection 15(2) is considered to

take precedence over section 80.4. As a result, shareholder loans and indebtedness will be

assessed under subsection 15(2) whenever that subsection applies, notwithstanding that section

80.4 would otherwise apply.



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Published May 2015

If a taxpayer has already reported a section 80.4 benefit when it should have been taxed under

subsection 15(2), a reassessment will be issued to delete the section 80.4 benefit and tax the

shareholder under subsection 15(2), unless the difference would be minor.

If a repayment of a loan or indebtedness has been made in a year, no carry-back to the previous

year will be permitted. Instead, assessments will be issued under subsection 15(2) and paragraph

20(1)(j) in respect of the years in which the loan or indebtedness was incurred and repaid.

Offsets can be allowed according to the policy described in the next section, Offsetting accounts

receivable and payable (paragraph five).

A shareholder loan or indebtedness, which is not taxable under subsection 15(2), will, of course,

be governed by section 80.4. Further, when the loan or indebtedness, or a major portion, arose in

a year which is now statute-barred, section 80.4 will be applied to tax the benefit until such time

as it has been repaid.

Offsetting accounts receivable and payable

Income Tax Interpretation Bulletin IT421R2, Benefits to individuals, corporations, and

shareholders from loans or debt, at www.cra-arc.gc.ca/E/pub/tp/it421r2/README.html,

paragraph 14, states that, "Generally, no netting or offsetting of any accounts "due to" or "due

from" the shareholder or employee will be deemed or considered to have taken place so as to

eliminate the calculation of a benefit during a particular period." However, offsets or netting will

be allowed in certain circumstances.

The CRA's policy on offsets or netting will apply to assessments issued under subsection 15(2)

as well as section 80.4.

Whenever offsets or netting are permitted, the corporation will be required to make all the

necessary entries and resolutions in its books and records in order to give proper (and legal)

effect to the offsets. This will have to be done before the audit is completed if the offset is to be

approved.

If it appears that an offset or netting will benefit a shareholder, that person must, in all cases, be

given the opportunity to request that it be applied.

Offsets can be allowed if the terms of the loans to and from a shareholder are the same. For

example, an interest-free loan from the corporation could be offset by a similar loan to the

corporation. On the other hand, if the loans have different terms (interest rate, period, or

maturity), no offset would be allowed.

If a third party lender to a corporation requires that a shareholder maintain a credit balance with

the corporation, that credit will not be available to the shareholder as an offset.

Offsets will not ordinarily be permitted if an individual has offsetting accounts with two different

corporations or if a corporation has accounts with different individuals. However, there could be

some situations where, in the auditor's judgement, a refusal to allow such an offset would be

clearly unfair. This could arise, for example, if the taxpayer was inexperienced and was

completely unaware of the tax implications and there appears to have been no reason for setting

up separate accounts in the first place.

Case law generally requires that the intention to offset be clear and unequivocal.

Go to:


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Published May 2015

• Wood v. MNR, 1988 (TCC) 88 DTC 1180

• Gannon v. MNR, 1988 (TCC) 88 DTC 1282

• Wolf v. MNR, 1992 (TCC) 92 DTC 1858

• Austin v. MNR, 1991 (TCC) 91 DTC 778

In order to ensure proper and legal effect, ensure that:

• a resolution about the offset is entered in the minute book of the corporation;

• a journal entry is made to the books and records of the corporation so that the balance

sheet reflects the offsetting of the receivable and payable; and

• the shareholder is asked to provide a written confirmation of the offset to the CRA.

Accrued salaries and bonuses

An accrued salary or bonus is taxable in an employee's hands when it is received. This is when a

cash payment is made or, if no such payment is made, when the amount is applied against

amounts owing by the employee to the employer.

If the employee has included the accrued salary or bonus in income at a particular time, but the

amount was not credited to that person's loan account, the employee and the employer will be

asked whether payment was made and if so, on what date. The salary or bonus will be considered

to have been paid on the day indicated by them for purposes of subsection 15(2) and section 80.4

according to the offset practice as discussed above.

Withholding tax ordinarily must be remitted to the CRA in the month following that in which the

payment or offset is made. Limit Audit involvement in connection with withholding

requirements on payments effected by offsets to a notification to the Trust Examination Section

that such an offset has been made. The extent to which these referrals are pursued is a decision to

be made by the Trust Examination Section and not by Audit.

If the employee and employer indicate that payment has not been made, the salary or bonus will

not constitute income in the employee's hands at that time, and an adjustment may have to be

made to delete it from the reported income. Subsection 78(4) may apply to the employer.

Accrued salaries and bonuses, which are used as offsets, will neither reduce nor eliminate any

benefits under section 80.4 arising prior to the effective date of the offsets.

The crediting of a bonus, salary, or a dividend against an existing debt does not, in any way,

mean that the debt has been brought into income. Consequently, paragraph 80.4(3)(b) does not

apply in this situation.

Calculation of the section 80.4 benefit

The shareholder loan and indebtedness accounts must be analyzed to arrive at the amounts

subject to subsection 15(2) and paragraph 20(1)(j).

The amount of the shareholder's loan or indebtedness that is not subject to section 80.4 must then

be determined in respect of each taxation year. This is done by totalling all amounts assessable

under subsection 15(2) for that year and all previous years, and subtracting from that total all

previous years' (but not the current year's) paragraph 20(1)(j) deductions. The date, in a taxation

year, on which an amount was borrowed or repaid, is not important. A subsection 15(2) amount

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Published May 2015

reduces the sum subject to section 80.4 with effect from the first day of the taxation year to

which it relates. A paragraph 20(1)(j) deduction, on the other hand, increases the sum with effect

from the beginning of the year after the one in which it is deducted.

If the balance at the end of a statute-barred year is assessable under subsection 15(2), calculate

two separate benefits under section 80.4 for transactions made:

1. in the current years the benefits are determined, as explained in the previous

paragraph; and

2. in statute-barred years, section 80.4 will apply to the full statute-barred balance.

Amounts assessed under subsection 15(2) are specific amounts on specific dates and are

removed from the calculations for section 80.4 benefits. When a deduction under paragraph

20(1)(j) is claimed for the repayment of a subsection 15(2) amount, it is treated similar to a debit

to the loan account on the first day of the taxation year following the taxation year in which it

was claimed.

Example

Corp A Ltd. loans its shareholder Mr. X $100,000 on July 1, 2010. Corp A has a June 30th

year

end. Mr. X makes his first repayment of $20,000 on January 15, 2013.

Result

Because the $100,000 was not repaid by the end of June 30, 2012, Mr. X will be assessed a

subsection 15(2) benefit on his 2010 T1 Income Tax and Benefit Return. On his 2013 T1 return,

Mr. X claims a paragraph 20(1)(j) deduction for $20,000. With no other transactions, beginning

on January 1, 2014, Mr. X will be receiving a benefit under section 80.4 based on the $20,000.

Because of the one-year repayment period set out in subsection 15(2.6), a follow-up audit may

be required if a loan or indebtedness arose in the most recent year filed.

Daily balances should be used to compute benefits according to section 80.4. However, in most

cases, the use of a balance, taken at some point in the month as the average for that month, will

yield the same results and is allowable. If these monthly balances are not representative or if the

taxpayer objects to their use, daily or weekly balances can be used.

Forgiven loans

As indicated in paragraph 11 of Income Tax Interpretation Bulletin IT421R2, Benefits to


arc.gc.ca/E/pub/tp/it421r2/README.html, if a loan to an employee is forgiven, the amount

forgiven is income in the hands of the employee in accordance with subsection 6(15). However,

paragraph 80.4(3)(b) would not apply to reduce any benefit included in the employee's income

according to subsection 80.4(1) in a prior year in respect of such a loan.

Similarly, if a loan to a shareholder is forgiven, the forgiven amount is income in the

shareholder's hands under subsection 15(1.2) in the year of forgiveness, but this would not

reduce a benefit included in income for a previous year under subsection 80.4(2), assuming that

subsection 15(2) did not earlier apply to the same loan.

Example 1 - Application of subsection 80.4(2)



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Published May 2015

The following example illustrates the calculation of a benefit under subsection 80.4(2) in 2013

for an individual who borrows $200,000 from the corporation in the capacity as a shareholder.

Suppose that the prescribed interest rate is 5% for the first three quarters of the year and 6% for

the last quarter. The loan was made on January 1, 2013, and no repayment has been made. The

shareholder paid $3,000 in interest in 2013 and $2,500 on January 10, 2014.

The benefit under subsection 80.4(2) would be:

$200,000 x 5% x 3/4 $7,500

$200,000 x 6% x 1/4 3,000

$10,500

Less: interest paid 5,500

Taxable benefit for 2013 $ 5,000

Example 2 - Application of subsections 80.4(1) and 80.4(2)

Facts

On May 15, 2013, Ms. F obtained a $200,000 loan from a financial institution to buy astronomy

equipment with the assistance of her employer, Zodiac Inc. She wasn't able to obtain the loan

without the help of her employer. The terms of the loan were:

• Ms. F had to make interest payments of $300 per month beginning June 30, 2013. Of this

amount, $200 had to be paid directly to the financial institution and $100 had to be paid

to the employer through payroll deductions. Ms. F was paid her salary on the 30th

of each

month. An annual principal repayment of $10,000 was due on November 15.

• Zodiac Inc. paid the financial institution monthly interest payments of $600, starting on

June 30, 2013.

Application of subsection 80.4(1)

Under subsection 80.4(1), Ms. F is deemed to have received a benefit equal to the amount, if any,

by which the total of:

a) the interest at the prescribed rate:

$200,000 x 5% x 45/365 days $1,233

$200,000 x 5% x 92/365 days 2,521

$200,000 x 6% x 45/365 days* 1,479

$190,000 x 6% x 47/365 days 1,468

$6,701

Plus

b) the interest paid or payable in the year by:

(i) the employer ($600 X 7 months) $4,200

(ii) and (iii) N/A 0 4,200

$10,901

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Published May 2015

Exceeds:

c) the interest paid on the loan by:

the employee ($200 x 7 months) $1,400

the employer ($600 x 7 months) 4,200 $5,600

d) any portion of the amount in (b)

paid by the debtor ($100 x 7 months) 700

$6,300

Benefit under subsection 80.4(1) $4,601

*The CRA calculates the period as including the first day, but excluding the date of the

repayment. This approach follows normal business practice.

According to subsection 6(9), Ms. F must include $4,601 in her income for the 2013 taxation

year as income from an office or employment.

Note that the interest the employer paid the bank is taken into consideration twice when

calculating the benefit. An amount of $4,200 was added to the calculation according to paragraph

80.4(1)(b), and the same amount was deducted under paragraph 80.4(1)(c). Therefore, the fact

that the employer paid interest on the employee's behalf did not increase the benefit deemed

received by the employee. The only time this situation will affect the calculation of the benefit, is

when the interest paid or payable by the employer (80.4(1)(b)) exceeds the interest actually paid

by the employer (80.4(1)(c)).

In summary, the deemed benefit ($4,601) equals the interest at the prescribed rate ($6,701) less

the interest Ms. F paid directly to the bank ($1,400) and the interest she reimbursed to Zodiac

Inc. ($700).

The net interest paid by Zodiac to the financial institution is a deductible business expense, to the

extent that such interest together with all other remuneration to Ms. F is reasonable in relation to

the value of the services she renders to her employer.

Note: This differs markedly from a loan received in a shareholder capacity. The

difference is attributable to the fact that employee-related expenses are considered laid

out for the purpose of earning income; whereas expenses related to shareholders do not.

Application of subsection 80.4(2)

If Ms. F is also a Zodiac shareholder and received the loan in this capacity, the benefit would be

calculated in the following way:

(a) The amount by which interest at the

prescribed rate

$6,701

Exceeds:

(b) The interest paid on the loan in the

year by:

Zodiac ($600 x 7 months) $4,200

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Published May 2015

Ms. F to the bank ($200 x 7 months) 1,400 5,600

Subsection 80.4(2) deemed benefit $1,101

(Benefit to the shareholder according to

subsection 15(9) and included in income

under subsection 15(1))

Benefit under subsection 15(1)

Personal expenses paid by the corporation $4,200

Less: amount repaid by Ms. F 700 3,500

Total benefit $4,601

Even though the total benefit is the same whether Ms. F receives the loan in her capacity as an

employee or shareholder, the amount of the benefit deemed to be interest paid under section 80.5

differs. If the loan was received in Ms. F's capacity as a shareholder, the deemed interest paid is

$1,101. In her capacity as an employee, it is $4,601.

24.12.7 References



• IT119R4, Debts of shareholders and certain persons connected with shareholders, at


• IT421R2, Benefits to individuals, corporations, and shareholders from loans or debt, at


Court cases

Loan and indebtedness

• Liffman et al. v. MNR, 1990 (TCC) 90 DTC 1854

• AC Simmonds & Sons Ltd. v. MNR, 1989 (TCC) 89 DTC 707

Subsection 15(2) of the ITA – Canadian Charter of Rights and Freedoms

• Laflamme v. MNR, 1993 (TCC) 93 DTC 50

Whether an estate was connected to the shareholders of a corporation

• Wright Estate v. The Queen, 1996 (TCC) 96 DTC 1509

Demand loans

• Perlingieri v. MNR, 1993 (TCC) 93 DTC 158

Loan received as borrower or shareholder

• Wolinsky et al. v. MNR, 1990 (TCC) 90 DTC 1854

Loan documentation

• Tick v. MNR, 1972 (FCTD) 72 DTC 6135

• D'Astous et al. v. MNR, 1985 (TCC) 85 DTC 440



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Training product

• TD1019-000, Shareholder’s Debt and Loans

Income Tax Rulings

• Document No. 9606625, May 3, 1996, Société Rattachée aux Associés Actionnaires

(available in French only)

• Document No. 9639060, December 10, 1996, Terms of repayment of shareholder loan

exempt by reason of subsection 15(2.3)

• Document No. 9234987, January 27, 1993, Foreign holiday dwelling

• Document No. 9509745, August 11, 1995, Shareholder/Employee Housing Loan 15(2),

80.4

Some of the comments in 24.12.4 were taken from TOM 13(15) 2.1 to 2.4. TOM 13 has been

withdrawn from circulation.

24.13.0 Transfer of property to a corporation by shareholders


Introduction

A person who wants to incorporate their business, would normally trigger tax consequences

when they disposed of their assets at FMV to the new corporation. However, the ITA allows a

transfer of eligible property for an elected amount if the shareholder or a member of a

partnership transfers the property to a "taxable Canadian corporation" or to a "Canadian

partnership." This amount may be different from the FMV under certain conditions, thereby

allowing the deferral of the tax implications that otherwise would occur upon disposition.

This section deals primarily with the CRA’s position if a property is transferred under section 85

of the ITA. Generally, however, the CRA policy with respect to rollovers may also apply to:

• subsection 93(1) - Election re disposition of share of foreign affiliate;

• subsection 97(2) - Rules if election by partners; and

• subsection 98(3) - Rules applicable if partnership ceases to exist.


24.13.2 Transfer of property - Income tax implications


Legislation

Section 85 of the ITA allows, under certain circumstances, a property rollover without causing

taxable income for the transferor. To make use of this section, the transferor and the corporation

(transferee) must complete and file Form T2057, Election on disposition of property by a

taxpayer to a taxable Canadian corporation, available at www.cra-arc.gc.ca/E/pbg/tf/t2057/. It

must be completed at the earliest due date of the income tax returns for either of the two parties

involved. The filing requirements and the late or amended filing of an election are set out in

subsections 85(6) to 85(9).


http://www.cra-arc.gc.ca/E/pbg/tf/t2057/

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Published May 2015

The transferor may be an individual, a corporation, or a trust and either a resident or

non-resident. A partnership may also be the transferor according to subsection 85(2), using Form

T2058, Election on disposition of property by a partnership to a taxable Canadian corporation,

available at www.cra-arc.gc.ca/E/pbg/tf/t2058/README.html.

When a non-resident makes a transfer of property under subsection 85(1), consult the TSO

International Audit Section to ensure the provisions of the ITA (for example, section 116 -

Clearance Certificate) and Income Tax Convention are considered.

The transferor’s property must be transferred to a "taxable Canadian corporation." Subsection

97(2) provides for a comparable rollover to a "Canadian partnership."

Property eligible for rollover

Only "eligible property" defined in subsection 85(1.1) may be transferred according to

subsection 85(1). Briefly, these properties are not eligible to be transferred:

• real property owned by a non-resident – paragraph (85)(1.1)(a);

• real property in inventory or held as "an adventure or concern in the nature of trade" –

paragraph 85(1.1)(f).

For more information on "eligible property," go to paragraph 4 of Income Tax Interpretation

Bulletin IT291R3, Transfer of property to a corporation under subsection 85(1), at www.cra-


Note: The inclusion of ineligible property in an election does not make the election in

respect of other eligible property invalid. A property omitted is considered a property

having been subject to a FMV disposition.

Agreed amount respects various limits

The amount (proceeds of disposition) the transferor and transferee agree to is the basis for

computing several of the income tax implications of a rollover. Although the taxpayers may

choose the agreed amount, subsection 85(1) sets out the range in which the agreed amount must

absolutely fall, as follows:

• Maximum limit for the agreed amount for an eligible property is always the FMV of the

property transferred (paragraph 85(1)(c)).

• Minimum limit for the agreed amount for an eligible property will depend on the type of

property being transferred, as illustrated by the following table.

Minimum limit is the greater of (a) and (b) below:

(a) For all property = FMV of non-share consideration (paragraph 85(1) (b))

Inventory

Non-depreciable

capital property

Depreciable capital

property

Eligible capital

property

(b) Lesser of:

• FMV of

property; and

(b) Lesser of:

• FMV of

property; and

(b) Least of:

• FMV of

property;

(b) Least of:

• FMV of

property;

http://www.cra-arc.gc.ca/E/pbg/tf/t2058/README.html



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Published May 2015

• tax value of

property

(paragraph

85(1)(c.1))

• ACB of

property

(paragraph

85(1)(c.1))

• UCC of class;

and

• cost of

property

(paragraph

85(1)(e))

• 4/3 of

cumulative

eligible capital

(CEC); and

• cost of

property

(paragraph

85(1)(d))

Order of property disposition

When more than one depreciable property or more than one eligible capital property are

transferred simultaneously to a corporation, each property is transferred as if they were done

separately in the order designated by the taxpayer according to paragraph 85(1)(e.1).

The transfer of the first depreciable property would reduce the balance of the UCC in its asset

class. When the next property is transferred, the UCC balance will reflect the transfer of the

previous property.

In general, if the non-share consideration received is not greater than the UCC of the asset class,

there is a disposition order that would allow a recapture to be avoided. However, if the non-share

consideration can be linked to a specific property, a recapture is possible.

Note: Depreciable properties are generally entered on the prescribed form by order of class.

The auditor must ask for the disposition order when the amounts of the transactions indicate

that a review is required. Audit findings that require further analysis include:

• very high cost of certain properties

• low UCC of the class

• few properties in the class

• non-share consideration linked to a specific property

Cost of the consideration received

The agreed amount is used to determine the transferor’s cost of all the properties received in

consideration.

The cost of the consideration can be determined as follows:

• The cost of the non-share consideration is determined based on its FMV – paragraph

85(1)(f).

• The balance (agreed amount minus the FMV of the non-share consideration) is attributed

to the preferred shares up to their FMV – paragraph 85(1)(g).

• If, after determining the cost of the non-share consideration and the preferred shares, an

agreed amount remains, it will be attributed to the common shares – paragraph 85(1)(h).

Nature of the shares received in consideration for the property

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Paragraph 85(1)(i) deems the shares received to be taxable Canadian property when the property

transferred was a taxable Canadian property for the transferor. Therefore, a non-resident could be

subject to tax in Canada on any gain realized on the sale of shares received as consideration.

Section 54.2 deems the shares received to be capital property when 90% or more of the assets

used in an active business were transferred to a corporation. Therefore, any later disposition of

shares will be treated as a taxable capital gain rather than as business income. A taxpayer who is

an individual could be eligible for the capital gains deduction according to section 110.6.

Paid-up capital adjustment

Subsection 85(2.1) is an anti-avoidance provision that allows the paid-up capital (PUC) of the

shares received, in consideration for a transferred property, to be adjusted. Paragraphs 85(2.1)(a)

and (b) are sometimes referred to as the “PUC grind” and “PUC bump,” respectively. These

paragraphs ensure that any increase in PUC in excess of the cost (usually the agreed amount)

minus the FMV of the non-share consideration is removed when considering certain later

transactions. Without the “grind,” when the shares were redeemed it was possible to avoid

deemed dividends under subsection 84(3) and instead experience gains which could have

preferential tax treatment. The “bump” generally ensures that the shares left in the class are not

affected.

When the auditor applies subsection 85(2.1), both the transferor and transferee listed on Form

T2057, Election on disposition of property by a taxpayer to a taxable Canadian corporation,

available at www.cra-arc.gc.ca/E/pbg/tf/t2057/README.html, or Form T2058, Election on

disposition of property by a partnership to a taxable Canadian corporation, available at

www.cra-arc.gc.ca/E/pbg/tf/t2058/README.html, must be informed in writing and a copy of

the letter must be added to the permanent document folder of both parties.

A reduction of PUC does not have immediate income tax implications. However, implications

occur when the PUC is used, such as at the time of the share repurchase or when the PUC is

returned to the shareholder. This is a permanent adjustment to a class of shares. When shares are

redeemed, the taxpayer must include the reduction of PUC in computing the deemed dividend

according to subsection 84(3). As PUC is calculated at any time, it does not matter if the year of

the rollover is statute-barred. As well, as the shares may have been sold multiple times and no

longer belong to the original shareholder, the reduction remains applicable whether or not the

taxpayer has been informed.

Following a share repurchase, a gross-up of the PUC is necessary according to paragraph

85(2.1)(b) so that the PUC of the remaining shares does not change. The basis for the calculation

is the PUC reduction at the time the PUC is calculated.

Cost of the property for the corporation

In general, the agreed amount according to section 85 is used to determine the cost of the

property for the "taxable Canadian corporation" or the "Canadian partnership."

However, the cost of a depreciable property for the purposes of computing the CCA may be

adjusted according to one of these provisions of the ITA:

• Paragraph 13(7)(e) if these conditions are met:

i) the transferor and transferee do not deal at arm’s length



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ii) the property was a capital property of the transferor

• Subsection 85(5) if the capital cost of the property for the transferor exceeds the agreed

amount

The application of paragraph 13(7)(e) or subsection 85(5) overrides any capital cost that could

have been determined under section 85. For the purposes of computing capital gains, the capital

cost does not change. That is, it corresponds to the agreed amount (any additional amount of

recapture because of subsection 85(5) will be removed in the determination of capital gain by

paragraph 39(1)(a)).

Income Tax Regulation 1100(2.2) excludes some depreciable properties from the half-year rule if

the transferor acquired and owned the property at least 364 days before the end of the

transferee’s taxation year in which the rollover occurred. The half-year rule would apply only if

the transferor owned the property for less than 364 days before the transferee’s year-end.

For more information on computing the acquisition cost, see Research Guide RG-41B, Capital

Cost of Certain Property - 1994 and subsequent years, paragraphs 13(7)(e) and (e.1) Rules

applicable, 13(7.3) Control of corporations by one trustee.

Other important issues to be considered

When a taxpayer transfers an eligible property to a taxable Canadian corporation according to

section 85, these provisions must be considered:

• subsection 13(21.2), if the transferor claims a loss on the disposition of a depreciable

property;

• subsection 14(3), if the corporation acquired an eligible capital property from the

shareholder with whom it does not deal at arm’s length;

• subsection 14(12), if the transferor claims a loss on the disposition of eligible capital

property;

• subsection 15(1), if a shareholder receives consideration greater than the FMV of the

property transferred to the corporation;

• subsections 40(3.3) to (3.6), if the transferor claims a loss on the disposition of an

undepreciable capital property;

• section 69, if the rollover occurred between non-arm’s length parties for inadequate

consideration;

• section 84.1, if an individual shareholder sold shares to a corporation with which the

shareholder does not deal at arm’s length;

• paragraph 85(1)(e.2), if it is reasonable to regard any part of the excess of the FMV of the

property transferred over the greater of the FMV of the total consideration or the amount

agreed to as a benefit that the taxpayer wanted to confer on a related person (the auditor

does not have to prove that it was the taxpayer’s "intent;" it is only necessary to

demonstrate that it is reasonable to regard the excess as a benefit – it is an objective test);

• subsection 85(2.1), if the PUC has not been adjusted correctly after applying subsections

85(1) or (2) to the disposition of a property;

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• section 212.1, if a non-resident shareholder sold shares to a corporation with which the

shareholder does not deal at arm’s length;

• subsection 55(2), if the eligible property is a share of the capital stock from which a

taxable dividend received was deducted according to subsections 112(1), 112(2), or

138(6) before the rollover; go to subsection 55(2) - Capital gains stripping, for more

information on the conditions when this anti-avoidance provision applies;

• subsection 245(2), in case of a tax avoidance transaction; and

• subsection 1100(2) of the Regulations, if the transferee claims CCA on the total cost and

not on 50% of the cost.

Before deciding to apply the provisions listed above, consult Real Estate Appraisal and/or

Business Equity Valuation to determine the FMV of the property transferred and the

consideration. For more information, go to 10.11.4, Referrals for real estate appraisal or

business equity valuation.

The value of a benefit may be reduced or cancelled if:

• the CRA approves the adjustment of the sale price when a price adjustment clause applies

to the transaction;

• the benefit stems entirely from an assessment and the shareholder wants to reimburse the

corporation according to the reimbursement policy.

24.13.3 Transfer of property - Guidelines


Consideration for a transferred property

The consideration for a transferred property must include shares of the capital stock of the

transferee corporation.

A rollover according to section 85 of the ITA without a share issue is not a valid election.

However, following the court’s decision in Dale et al. v. The Queen, 97 DTC 5252 (FCA), the

CRA accepts, under certain specific conditions, elections if the issue of shares occurred after the

transfer for legal reasons. According to this case, the CRA must respect the legislation of a

province. Justice Robertson stated:

"If the legislature of a province authorizes its courts to deem something to have occurred on a

date already past, then it is not for the Minister to undermine the legislation by refusing to

recognize the clear effect of the deemed event".

The CRA accepts the elections made according to section 85 if shares given in consideration do

not have to be issued in due form at the time of the transfer if:

• the transferor and transferee agreed, among other things, that the transferee will issue the

required shares;

• the transferee immediately takes the necessary action to authorize the issuance of shares

by presenting letters patent or articles of amendment, depending on the case; and

• the transferee corporation immediately issues the shares once the necessary amendments

have been made to the corporation’s incorporating document.

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If, for whatever reason, the transferee corporation does not obtain, according to relevant

provisions of corporate law, the necessary authority to issue shares, the election made according

to section 85 will be considered invalid.

24.13.4 Section 85 of the ITA - Acceptable amended election


Late or amended elections made according to section 85 are acceptable if the taxpayer pays an

estimate of the penalty in one of the following situations:

• The taxpayer wishes to correct errors or omissions. Note that clerical errors corrected by

the tax center do not require an amended election.

• The CRA recognizes a price adjustment clause in a sales contract. Note that a price

adjustment clause does not automatically amend an election made according to section 85

and that the taxpayer must file an amended election according to subsection 85(7.1). The

circumstances in which a price adjustment clause will be recognized and where an

adjustment of the agreed amount could be made are set out in paragraph 26 of Income

Tax Information Circular IC76-19R3, Transfer of property to a corporation under section

85, at www.cra-arc.gc.ca/E/pub/tp/ic76-19r3/README.html.

Following an assessment and the CRA’s recognition of a price adjustment clause, the

implications are the same as those mentioned in 24.10.4 section, Reimbursement policy.

A taxpayer may file an amended election without incurring a penalty if:

• the taxpayer or the CRA is making corrections only to clerical errors, notably to

typographical errors, transcription errors, composition errors, and calculation errors;

• the information on the prescribed form, other than the agreed amount, remains the same

despite a correction to the election. For example, an incorrect ACB on the prescribed

form may be corrected at any time. If the ACB is not corrected and if the prescribed form

is statute-barred, the ACB of the transferred property can nevertheless be indicated

according to the appropriate value since the actual ACB is not statute-barred.

Ineligible amended election

Amendments to an election filed under section 85 will not be accepted when the main objective

is to:

• conduct retroactive tax planning;

• take advantage of the laws passed after the date of the initial election;

• evade or avoid income tax;

• amend the agreed amount in the case of a statute-barred year.

Related subject

Go to 28.6.0, Penalties for late filed and/or amended elections under the ITA.

24.13.5 Section 85 of the ITA rollover checklist



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Corporations commonly use the provisions of subsection 85(1), thereby electing to roll over

"eligible property" in matters related to tax planning. A number of problems can result from an

invalid election.

The following checklist helps to determine the validity of an election and to make the necessary

adjustments under the provisions of the ITA and more specifically subsections 15(1), 69(4),

85(1), 85(2.1), and paragraph 85(1)(e.2). A separate checklist is required for each property.

Identification

Taxpayer:

Account No:

Case No.: File No.: Date:

Election

Yes No WP Ref.

1. Has the election been confirmed by a

resolution in the minute book?

2. Does the agreed amount meet the

various limitations of subsection 85(1)? If

not, the agreed amount will be adjusted

under paragraph 85(1)(b) to (e.4)

Valuation of Property

1. Is it necessary to have the transferred

property or the consideration received

(other than as a share) valued by Business

Equity Valuation? The following can be

used to help determine whether a referral

is necessary:

a) Agreed amount = FMV of the

property

b) Capital gains deduction claimed

under section 110.6

c) Net capital loss carried over to the

rollover year

d) Relatively high FMV of the

rolled-over property

2. Is it reasonable to consider the FMV of

the transferred property that exceeds the

higher of the FMV of the total

consideration or the agreed amount as a

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benefit that the taxpayer wanted to confer

on a related person? If yes, paragraph

85(1)(e.2) may apply.

3. Is the FMV of the consideration

received by the transferor greater than the

FMV of the property transferred to the

corporation? If yes, the transferor received

a taxable benefit under subsection 15(1).

4. If a price adjustment clause is included

in the contract of sale, does the clause

meet the conditions specified in Income

Tax Folio S4-F3-C1, Price adjustment

clauses, at www.cra-

arc.gc.ca/tx/tchncl/ncmtx/fls/s4/f3/s4-f3-

c1-eng.html? If yes, the taxpayer could

make an amended election under

subsection 85(7.1) if it pertains to a

valuation.

Parties Involved

1. Is the transferee a "taxable Canadian

corporation"? If not, the election is

invalid.

2. Did the transferor report a capital gain

or business income upon sale of the

transferred property?

3. Did the transferor claim a terminal loss,

a capital loss, or a terminal allowance

under paragraph 24(1)(a)? If yes, a loss

claimed after April 26, 1995, is deferred

or depreciated in an "affiliated" situation

in compliance with subsections 13(21.2),

14(12), or 40(3.2) to (3.6).

4. Did the transferee report a capital gain

or business income at the time of the

appropriation of property to a

shareholder? The proceeds of disposition

are equal to the property’s FMV in

compliance with subsection 69(4).

Eligible Property

1. Has the transferor made an election on




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ineligible property? If yes, this situation

has no bearing on the rest of the rollover.

"Eligible property" is defined in

subsection 85(1.1).

2. Are all properties included in the

contract of sale indicated on the

prescribed form? If not, omitted property

is considered property that was disposed

of according to its FMV. The taxpayer

could make an amended election to

correct the situation.

3. Were shares that constituted capital

property for an individual transferor,

transferred to a corporation with which

the transferor had a non-arm’s length

relationship? If yes, consider the

application of section 84.1.

4. Were a number of eligible properties

transferred? If yes, ask the taxpayer for

the order in which each eligible capital

property and each depreciable property

was disposed of. An analysis may be

warranted.

5. Is the eligible property a share of

capital stock for which a taxable dividend

received was deducted under subsection

112(1), 112(2), or 138(6)? If yes, consider

the application of subsection 55(2) if the

transaction is part of a transaction, an

event, or a series of transactions or events.

Consideration received by the Transferor

1. Did the transferor receive shares in

consideration of the transferred property?

If not, the rollover is not a valid election.

2. Does the share ledger confirm the issue

of shares by the corporation?

3. Was the cost of the consideration

received computed in compliance with

paragraphs 85(1)(f) to (h)?

4. Can the increase in paid-up capital for

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shares lead to a deemed dividend by

applying subsection 84(1)?

5. Does the paid-up capital for shares

issued need to be adjusted in compliance

with section 84.1, section 212.1, or

subsection 85(2.1)?

Depreciable Property

1. Is the cost of the property for the

transferee greater than the cost for the

transferor? If yes, the maximum CCA that

the transferee may claim is computed

based on the cost of the property

determined in paragraph 13(7)(e).

2. Is the cost of the transferred property

for the transferor greater than the agreed

amount? If yes, the maximum CCA that

the transferee may claim is computed

based on the cost of the property

determined in subsection 85(5).

3. Did the transferee claim CCA during

the year of the transfer? If yes, does the

half-year rule of subsection 1100(2) of the

Regulations need to be applied?

4. In the case of a "rental property," did

the CCA claimed create a rental loss? If

yes, part of the CCA claimed may be

disallowed under subsection 1100(11) of

the Regulations.

5. In the case of a passenger vehicle

transferred to a related corporation, is the

transferor continuing to use the vehicle for

personal use? If yes, the benefit for the

right of use for an automobile must be

computed based on the FMV of the

vehicle prior to the rollover under

paragraph 85(1)(e.4).

Eligible Capital Property

1. If the goodwill was transferred as part

of a rollover, did the taxpayer indicate a

nominal value for the goodwill generated

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by the business? "Nil" is not a nominal

value.

2. Did the transferor claim an amount as a

deduction from capital gains for the

disposition of an eligible capital property?

If yes, the transferee’s eligible capital

expenditure may be reduced under

subsection 14(3).

Debts

1. When accounts receivable are

transferred to a corporation as part of the

transfer of all or substantially all of the

business from the transferor to the

corporation:

a) Did the transferor incur a loss upon

disposition of the accounts receivable?

If yes, the loss is usually a capital loss

unless the transferor is a trader in

accounts receivable.

b) Did the transferor claim a reserve

for the accounts receivable

transferred? If yes, the claim is not

eligible.

c) Did the transferee claim a reserve

under paragraphs 20(1)(l) or (p) with

regard to the accounts receivable

acquired? If yes, the deduction cannot

be claimed. However, the effect of

section 22 election would have to be

considered.

Transactions following a Rollover

1. Did the transferee dispose of the

eligible capital property following the

rollover? If yes, an adjustment to the

"cumulative eligible capital" may be

needed under paragraph 85(1)(d.1).

2. Did the transferee proceed with the

purchase of shares issued at the time of

the rollover? If yes, the reduction in

paid-up capital under subsection

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85(2.1)(a) on the redeemed shares must be

added back under subsection 85(2.1)(b)

when establishing the paid-up capital of

the remaining shares.

3. Were the shares received by the

transferor "taxable Canadian property" or

capital property? The treatment of a gain

realized when the shares are disposed of

in the future will depend on the type of

shares.

Conclusion

The provisions of subsection 85(1) are met Yes No

Auditor: Date:

Team Leader: Date:

Example of rollover according to subsection 85(1) of the ITA

The facts according to Form T2057, Election on disposition of property by a taxpayer to a

taxable Canadian corporation, available at www.cra-arc.gc.ca/E/pbg/tf/t2057/

Particulars of eligible property disposed:

Land FMV $650,000 iii

*

ACB $200,000

Particulars of consideration received:

Painting FMV $125,000

10 preferred shares FMV/PUC $525,000

Agreed amount: $200,000

Description of the preferred shares received:

Share redemption value $52,500

Stated capital $52,500

What are the tax implications?

The solution

1. The conditions for applying subsection 85(1) are met.

2. The agreed amount of $200,000 satisfies the various limits.

http://www.cra-arc.gc.ca/E/pbg/tf/t2057/

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3. The cost of the non-share consideration (painting) = $125,000.

4. The cost of the preferred shares = $200,000 - 125,000 = $75,000.

5. The reduction of PUC = stated capital - (excess of agreed amount over the non-share

consideration)

= $525,000 - (200,000 - 125,000)

= $450,000

6. The PUC = stated capital - reduction = $525,000 - 450,000 = $75,000.

7. The benefit the shareholder received corresponds to the difference between the FMV of

the properties received and the FMV of the properties transferred, that is, ($650,000 -

500,000) = $150,000.

8. Subsection 84(1) does not give rise to a deemed dividend since the net increase in the

value of the assets ($500,000 - 125,000 = $375,000) is greater that the increase in the

PUC of the shares ($75,000).

9. The benefit to include in the shareholder’s income according to 15(1) is $150,000

($650,000 - 500,000 - 0 (deemed dividend)). This benefit may be reduced or offset

subject to the CRA’s reimbursement policy in 24.10.4.

10. The ACB of the preferred shares received is increased by the benefit according to

subsection 52(1).

11. The taxpayer may submit an amended Form T2057 and pay the penalties provided a price

adjustment clause was filed with the original Form T2057.

12. The auditor considers waiving any penalty according to subsection 220(3.1).

References

Income Tax Folio

• S4-F3-C1, Price adjustment clauses, at www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s4/f3/s4-

f3-c1-eng.html


• IT291R3, Transfer of property to a corporation under subsection 85(1), at www.cra-


• IT471R, Merger of partnerships, at www.cra-arc.gc.ca/E/pub/tp/it471r/README.html

• IT413R, Election by members of a partnership under subsection 97(2), at www.cra-


Income Tax Information Circular

• IC76-19R3, Transfer of property to a corporation under section 85, at www.cra-

arc.gc.ca/E/pub/tp/ic76-19r3/README.html

Other










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• Research Guide RG-41B, Capital Cost of Certain Property - 1994 and subsequent years,

paragraphs 13(7)(e) and (e.1) Rules applicable, 13(7.3) Control of corporations by one

trustee

• Learning product TD1004-000, Section 85 Rollovers

i Note 1: The expenses during the three months the property is used for personal use are limited

to the rent the shareholder paid. ii Note 2: Since the condominium is used partly for business purposes, the corporation may

deduct CCA for the part of the year the condominium is rented to parties with whom the

corporation deals at arm's length. iii

* The FMV of the land is adjusted to $500,000 following receipt of the appraisal report.


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