Principal Issues
- Whether interest on borrowed funds used to make intercorporate loans is deductible under paragraph 20(1)(c) of the Income Tax Act.
- Whether an interest-free intercorporate loan results in a taxable shareholder benefit under subsections 15(1), 56(2), or 246(1).
Position
- Interest deductibility depends on whether the borrowed funds are used for the purpose of earning income.
- Interest-free intercorporate loans are generally not deductible, unless an indirect income-earning purpose can be demonstrated.
- A bona fide intercorporate loan will generally not result in a shareholder benefit, provided there is a reasonable expectation of repayment.
Reasons
Pursuant to paragraph 20(1)(c) of the Act, interest is deductible only where borrowed money is used for the purpose of earning income from a business or property.
Where borrowed funds are used to make an interest-free loan, there is generally a direct ineligible use, as no income is generated from the loan.
However, the CRA has accepted that interest deductibility may be permitted in exceptional circumstances, including situations where:
- the loan is made to a wholly-owned subsidiary, and
- the funds are used to generate income that may increase dividend returns to the lender.
In addition, indirect use principles may apply where the taxpayer can demonstrate a bona fide purpose of earning income, even where the immediate use of funds appears ineligible.
Where an interest-bearing (even nominal) rate is charged on an intercorporate loan, the direct use and purpose tests are generally satisfied, subject to the specific facts.
With respect to shareholder benefits, a bona fide intercorporate loan does not generally constitute a payment or transfer of property, and therefore:
- subsection 56(2) will typically not apply, and
- subsection 15(1) will generally not apply, provided the loan is genuine and repayable.
Similarly, the CRA has indicated that an interest-free loan between corporations will generally not result in a taxable benefit to a shareholder, unless:
- there is no reasonable expectation of repayment, or
- value has been permanently shifted out of the lending corporation.
Where a loan is subsequently forgiven, the transaction may be recharacterized as a transfer of property, potentially engaging subsection 56(2) or other provisions of the Act.
Limitations
The tax treatment of intercorporate loans is highly dependent on the specific facts and circumstances, including:
- the relationship between the corporations;
- the presence or absence of interest;
- the intended use of funds; and
- the ability and intention to repay the loan.
These comments are general in nature and do not constitute a binding ruling.
Binding confirmation may only be obtained through an advance income tax ruling request submitted in accordance with CRA administrative procedures.
