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At the CALU Annual Meeting on May 9, 2006, Phil Jolie, Acting Director of the Business and Partnerships Division of the Income Tax Rulings Directorate of the Canada Revenue Agency (CRA), responded to various questions regarding technical issues of current concern. The following are the questions and the CRA's position on the respective issues. For some questions, CALU has provided a note of clarification or comment concerning the official responses. Ourthanks to Ted Ballantyne, Director, Advanced Tax Policy, CALU for his work in developing and coordinating both the Tax Roundtable and this CALU Report and William R. Holmes, Partner, Thorsteinssons,CALU's Tax Advisor, for his participation in the Roundtable. All statutory references are to the Income Tax Act unless otherwise specified.
Where a taxpayer has assigned a life insurance policy as collateral for a loan, and the conditions of paragraph 20(1)(e.2) are satisfied, the taxpayer is permitted to claim a deduction each year in respect of premiums payable under the policy. The amount that may be deducted in a year is equal to that portion of the lesser of the premiums payable for the year and the net cost of pure insurance (NCPI) in respect of the year that "can reasonably be considered to relate to the amount owing from time to time during the year by the taxpayer".
Where a life insurance policy has a cash surrender value it is unclear how to determine the portion of the premiums or NCPI that is considered to relate to the amount owing.
Assume that paragraph 20(1)(e.2) is applicable with respect to a life insurance policy that has been assigned by a taxpayer as collateral for a loan. The relevant amounts for a particular taxation year are as follows:
Death benefit = $1,000,000
Cash surrender value = $ 300,000
Amount owing = $ 500,000
The net amount at risk is $700,000 ($1,000,000 - $300,000), which is the amount of insurance for which the NCPI is determined. Assume that the premiums payable by the taxpayer for the year exceed the NCPI for the year, so that the taxpayer's deduction under paragraph 20(1)(e.2) is based on the NCPI.
(a) What is the CRA's view on how the taxpayer's deduction in the above example should be determined?
(b) If in the above example the premiums payable for the year were less than the NCPI for the year, would the taxpayer's deduction be determined in the same manner using the amount of the premiums instead of the NCPI?
(a) To date, as evidenced by Interpretation Bulletin IT-309R2 Premiums on Life Insurance Used as Collateral, the Agency has taken a rather simplistic approach in determining the amount of the premium deductible where a life insurance policy has been assigned as collateral for a loan under paragraph 20(1)(e.2). The premium deductible under paragraph 20(1)(e.2) is calculated with reference to the death benefit payable under the insurance policy and the outstanding amount of the loan without reference to other collateral or the cash surrender value of the policy.
As the death benefit in the example referred to above is $1,000,000 and the loan amount is $500,000 in accordance with the approach referred to in IT-309R2 the amount of the premium deductible under paragraph 20(1)(e.2) will be calculated as 50% of the NCPI, as it is assumed that the premiums payable by the taxpayer for the year exceed the NCPI for the year.
Assume that a partnership borrows money from a restricted financial institution and that the interest on the loan is deductible in computing the partnership's income. The financial institution requires one of the partners to assign a life insurance policy as security for the loan.
Would the partner be entitled to claim deductions under paragraph 20(1)(e.2) in respect of premiums payable under the life insurance policy?
No. One of the requirements for the deduction of premiums under paragraph 20(1)(e.2) is that the interest on the borrowed money be deductible in computing the income of the taxpayer who paid the premiums. In the example above, the interest is deductible by the partnership in computing partnership income by virtue of subsection 96(1), rather than in computing the income of the partner who is paying the premiums.
A trust to be created under the terms of a taxpayer's will is intended to meet the conditions imposed by subsection 70(6) of the Income Tax Act (the "Act"). The terms of the trust would allow the trustee to retain ownership of any life insurance policies acquired as a consequence of the taxpayer's death. Premiums under the life insurance policies would, under the terms of the trust, be required to be paid from the capital of the trust.
Subsection 70(6) of the Act provides that, if certain conditions are met, a transfer of the taxpayer's capital property following the taxpayer's death to the trust will occur on a tax-deferred basis. One of the conditions imposed by the subsection is that the trust be one under which no person except the spouse or common-law partner of the taxpayer may, before the spouse or common-law partner's death, receive or otherwise obtain the use of any of the income or capital of the trust. This condition is imposed by subparagraph 70(6)(b)(ii) of the Act.
What are the CRA's views on whether the condition imposed by subparagraph 70(6)(b)(ii) will be satisfied given the trust's terms regarding life insurance policies?
For the purpose of this reply, a reference to a "policy beneficiary" in respect of an insurance contract means a person, referred to in the contract or by a declaration, to whom or for whose benefit insurance money under the contract is made payable. A reference to a "trust beneficiary" in respect of a trust means a person who is a beneficiary of the trust.
Principles of insurance law and trust law both would apply in informing our understanding of the nature of the legal relations involved in the circumstances described in your question. These principles may vary from province to province. For example, provincial insurance law may not be fully uniform in setting out the circumstances, if any, in which a person acting as trustee may acquire other than by operation of law (e.g., as a personal representative) ownership of a life insurance policy.
Therefore, we are unable to provide a detailed reply to your question.
To provide a detailed reply to your question we would require additional information, including:
(1) the applicable provincial law governing the policy and the trust,
(2) the nature of the life insurance provided under the policy (e.g., an annuity, segregated fund, or pure life insurance),
(3) whether the premiums are fully paid,
(4) whether policy beneficiaries have been designated by the owner or named in the contract and, if so, whether the designations are irrevocable,
(5) an analysis of whether under the applicable law a trustee can acquire an ownership interest in the policy and, if so,
(6) whether the policy beneficiaries are trust beneficiaries.
We are prepared, however, to offer some general comments on the potential income tax consequences in the circumstances you describe.
We have assumed that the insurance policy in question is not an annuity or segregated fund contract, and that the contract provides only benefits in respect of pure life insurance (i.e., benefits arising only on the death of the life insured) such that no part of the contract premium payments relates to any benefit other than pure life insurance protection. We have assumed that payment of the contract premium has the effect of maintaining, for the period covered by the premium, the contract and, therefore, the policy beneficiary's right to receive insurance proceeds under the contract.
In acquiring trust property a trustee is, under general trust law principles, bound by the terms of the trust in dealing with the property. For a trustee to acquire and maintain ownership of a contract of insurance would require that the trustee act under some duty that obliges it, or power that enables it, to do so. Thus, in the context of a trustee owning a life insurance policy, the trustee's actions in acquiring the policy and paying the contract premiums could not be inconsistent with the terms of the trust and those actions would have to be in the best interests of the trust beneficiaries.
The acquisition and subsequent payment of premiums by a trustee of a contract of pure life insurance does not, under ordinary trust law principles, appear to fall within a trustee's powers or duties regarding administration, management or investment of trust property. A contract of pure life insurance is different in this regard from a contract to insure against loss or damage to property (which may be required in fulfillment of the trustee's obligation to manage trust property) or an annuity contract issued by an insurer (which may involve an investment of trust property even though the contract may be classified as a contract of life insurance under provincial law). In our view, the payment by the trustees of the premiums under a contract of pure life insurance would occur in fulfillment of what is sometimes referred to in trust law as a dispositive power in respect of trust property that is to say, the premium payments would be made under a power or duty to allocate trust property in favour of the trust beneficiaries.
It would follow from this that the trustee's actions in respect of the contract could not be inconsistent with the dispositive powers in respect of the trust property and that the policy beneficiary(ies) would have to be trust beneficiary(ies).
Based on these assumptions (including the assumption that a trustee would under the insurance law and trust law principles applicable in the circumstances you describe be capable of owning a contract of life insurance), we offer the following general comments.
(i) The conditions imposed by subparagraph 70(6)(b)(ii) of the Act
The payment of a contract premium by the trustee to the insurer out of the capital of the trust would result in the policy beneficiaries obtaining the benefit of the trust capital paid to the insurer. This is because, as noted above, the premium payment is assumed to have the effect of maintaining, for the period covered by the premium, the policy beneficiaries' right to receive insurance proceeds. Therefore, upon the premium payment, the policy beneficiaries obtain the use of that trust capital within the meaning of subparagraph 70(6)(b)(ii) of the Act and if the policy beneficiaries, at the time the trust sought to meet the condition contained in subparagraph 70(6)(b)(ii), could be any person(s) other than the trust beneficiary referred to in that subparagraph (i.e., the surviving spouse or common-law partner of the deceased taxpayer), the capital use requirements in that subparagraph would not be met at that time.
We note in this regard that the condition in subparagraph 70(6)(b)(ii) is that no person except the surviving spouse or common-law partner may, before the surviving spouse's or common-law partner's death, receive or otherwise obtain the use of any of the income or capital of the trust (emphasis added). Our position (see, for example, our opinion in document 2002-0127075) is that the mere power to encroach on the capital of a trust for the benefit of persons other than the surviving spouse or common-law partner beneficiary, prior to the surviving spouse's or common-law partner's death, is sufficient to disqualify a trust from the rollover provisions contained in subsection 70(6) of the Act. Support for our position is found in the decisions of Peardon v. M.N.R.,  1 C.T.C. 2083 (T.C.C.) and Johnson v. Minister of National Revenue  C.T.C. 2388 (T.C.C.).
Accordingly, we would consider the capital use requirement in subparagraph 70(6)(b)(ii) of the Act to be satisfied only if:
the terms of the trust permitted no person other than the surviving spouse or common-law partner to be, during the lifetime of surviving spouse or common-law partner, a policy beneficiary, and
the surviving spouse or common-law partner were at every time at which the trust owned the policy validly named or designated as the only policy beneficiary under the policy.
(ii) Application of section 105
Whether the trust is one that seeks to satisfy the requirements of subparagraph 70(6)(b)(ii) of the Act or not, and whether the premium is paid out of the trust's income or capital, it would appear that the policy beneficiary would have a benefit, from the trust's payment of the policy premium, resulting in the application of section 105.
One of the amounts included in computing the adjusted cost basis (ACB) of a life insurance policy to the policyholder is the premium paid under the policy. Pursuant to the definition of "premium" in subsection 148(9), premiums do not include the portion of any amount paid under a policy with respect to "an additional risk as a result of insuring a substandard life". Thus, to the extent that the premiums under a policy are higher than the standard premiums because of the state of health of the life insured, the additional amount of premiums would not be included in computing the ACB of the policy.
The issue in this question is whether the exclusion applies with respect to premiums paid under a universal life insurance policy where the life insured is a substandard risk. The relevant policy terms are as follows. The policy allows the policyholder to pay premiums each year within a range of permissible amounts. Premiums (net of related premium tax) are credited to the policy fund, which is used to determine the cash surrender value of the policy. A monthly charge is deducted from the policy fund in respect of the mortality risk assumed by the insurer and the insurer's administration costs. The monthly mortality charge is higher than it would be if the life insured were in a good state of health.
Does the CRA agree that the full amount of each premium paid under the universal life insurance policy is included in the ACB of the policy?
In calculating the ACB of a life insurance policy pursuant to subsection 148(9) a deduction is made for the net cost of pure insurance (NCPI) of the interest in the policy pursuant to component L. The NCPI, which is calculated pursuant to section 308 of the Income Tax Regulations, is calculated with reference to mortality tables based on standard lives. This will be the case whether the policy is a whole life policy or a universal life policy.
Accordingly where the premium paid under the policy is in respect of a substandard life the portion of the premium that is in respect of the additional risk as a result of insuring a substandard life is not added to the policy pursuant to component B of subsection 148(9).
The monthly mortality charge, which is deducted from the policy fund, affects the cash surrender value of the policy but is not taken into account in computing the deduction for NCPI under component L of the ACB calculation of the policy. Therefore as the premium paid over the life of the policy will include an amount with respect to the additional risk for insuring a substandard life the full amount of the premium cannot be included in the ACB of the policy. Only the portion of the premium that does not relate to an additional risk as a result of insuring a substandard life should be included in computing component B of the ACB pursuant to subsection 148(9).
CALU Comment: It is unclear how to apply the CRA's position when the premiums paid under a UL policy exceed the minimum level to keep the policy in force. Unfortunately, the CRA did not provide any guidance.
Where a corporation disposes of an interest in a life insurance policy, the corporation is required by paragraph 56(1)(j) to include in its income the amount, if any, determined under subsection 148(1) or (1.1) in respect of the disposition. It is unclear whether, for purposes of the definition of "aggregate investment income" in subsection 129(4), such an amount is income of the corporation from a source that is property.
Does the CRA agree that an amount included in the income of a corporation by reason of paragraph 56(1)(j) is also included in determining the corporation's aggregate investment income?
At issue is whether an amount that is included in a corporation's income under paragraph 56(1)(j) in respect of the disposition of an interest in a life insurance policy is considered income from a source that is property for the purposes of paragraph (b) of the definition of "aggregate investment income" in subsection 129(4).
It is our view that where an amount in respect of a disposition of a corporate owned life insurance policy is included in the corporation's income pursuant to paragraph 56(1)(j) such amount may reasonably be considered as being income from a source that is a property for purposes of paragraph (b) of the definition of "aggregate investment income" in subsection 129(4).
In order for a corporation to qualify as a "small business corporation," as defined in subsection 248(1), it must satisfy an asset test. All or substantially all of the fair market value of the corporation's assets must be attributable to the types of assets listed in the definition.
Is the amount of the corporation's refundable dividend tax on hand to be included as an asset for the purpose of this test?
Does the CRA's response depend on whether the corporation has paid any taxable dividends in its taxation year that includes the time at which its status as a small business corporation is being tested?
The question of whether a particular asset is an "asset used principally in an active business" is one of fact which must be determined based on all the relevant facts and circumstances of each case. The relevant circumstances include the actual use to which the property is put in the course of the business, the nature of the business and the practice in the particular business.
In determining whether a corporation is a small business corporation, the CRA does not take into consideration the portion of a corporation's refundable dividend tax on hand for which no dividend refund is made. Refundable dividend tax on hand is a notional account that is required to be calculated based on the applicable law in the Income Tax Act.
Generally, the CRA is of the opinion that a dividend refund receivable by a corporation as a result of paying taxable dividends to shareholders constitutes an eligible asset that is used by the corporation in a business.
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a) A taxpayer borrows money to acquire an income-producing property. The interest on the loan is deductible under paragraph 20(1)(c). At a later date, the taxpayer borrows a further amount of money which is also used for an income-earning purpose. The taxpayer subsequently sells the property acquired with the first loan and uses the proceeds to repay a portion of the second loan. Does subsection 20(3) apply to deem the money borrowed under the first loan to have been used for the purpose for which the money borrowed under the second loan was used?
b) If subsection 20(3) does not apply in the situation above, is the money that was borrowed under the loan considered, on general principles, to be used for the purpose for which the money borrowed under the second loan was used?
a) No. The preamble of subsection 20(3) and the words "previously borrowed" contained in paragraph 20(3)(a) would not be met as proceeds of disposition from the property acquired with the first loan, not borrowed money, was used to repay the second (later) loan. It should be noted that even if the ordering of the loans was reversed such that the ordering issue in paragraph 20(3)(a) is resolved, the words in subsection 20(3) would not be met as "proceeds of disposition" are not "borrowed money."
b)No. If the conditions in subsection 20(3) have not been met, general principles would not operate to deem the use of borrowed money used to repay another borrowing to have been used for the purposes for which the money repaid was used. To conclude otherwise would make subsection 20(3) redundant. However, any given scenario needs to be considered and resolved based on the particular facts which include a review of the loan arrangement as supported by documentation.
CALU Comment: Note that the CRA's response includes their position on the scenario where the loans are reversed (i.e., the proceeds from the sale of property acquired with the second loan are used to repay the first loan). This scenario had not been included as part of the question, since it was thought that there would not be any issue regarding the deduction of interest.
Steps are sometimes taken after the death of an individual who controls a corporation to increase the adjusted cost base (ACB) of the corporation's non-depreciable capital property. Such steps generally involve the transfer of the shares of the old corporation that were owned by the deceased to a new corporation, winding up the old corporation, and making designations under paragraph 88(1)(d) in respect of some or all of the eligible property of the old corporation. These steps could be implemented by the estate or by the beneficiaries to whom the shares are distributed by the estate. Generally, this tax planning technique achieves the intended result only if paragraph 88(1)(d.2) and (d.3) deems the new corporation to have last acquired control of the old corporation immediately after the death of the individual. Similar tax planning may also be considered where shares are held in an alter ego trust, a spousal trust, or a joint spousal or common-law partner trust. The bump would be implemented after the death of the individual who is the initial income beneficiary of the alter ego, spousal or common-law partner trust, or the death of the last to die of the individuals who are the initial income beneficiaries of the spousal or common-law partner trust. However, it is unclear in these types of situations whether paragraph 88(1)(d.2) and (d.3) would deem the new corporation to last acquire control of the old corporation on the death of the relevant individual.
While we understand that the CRA has provided some favourable rulings on the above types of situations we would appreciate the CRA's current views on the proper interaction of paragraphs 88(1)(d.2) and (d.3).
It is our understanding that the current tax policy of paragraphs 88(1)(d.2) and (d.3) is to treat an acquisition of control of a subsidiary corporation that arises solely because of an acquisition of shares of the corporation as a consequence of the death of an individual as being similar to that of an acquisition of control of a corporation that arises on a true arm's length takeover of the corporation for the purposes of paragraphs 88(1)(c) and (d) (the "bump rules").
CRA has considered the application of these provisions in the past in situations similar to those described above. In each of the situations where we have ruled favourably, the particular transactions in question did not violate our understanding of the underlying tax policy of the bump rules at the time such transactions were undertaken, such that the particular parent corporation was considered to have "last acquired control" of the particular subsidiary corporation for the purposes of paragraphs 88(1)(c), (d) and (d.2) at the time immediately after the particular individual's death.
While we agree that the wording of paragraph 88(1)(d.2) makes it somewhat difficult to ascertain what the appropriate result should be in all circumstances, we are prepared, on a case-by-case basis, to continue to provide rulings on post-mortem "bump" transactions where all relevant facts are identified and the particular transactions in question do not, in our view, contravene our understanding of the current tax policy of the bump rules.
CALU Comment: For examples of CRA rulings on this issue, see CRA Documents 2004-0088551R3, 2004-0060271R3, 2002-0148283, 2002-0122743 and 2001-0093363.
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In a recent technical interpretation (Document No. 2005-0148221E5, dated Nov. 21, 2005), the CRA provided comments with respect to a situation where a corporation was considering the purchase of insurance policies to provide salary protection to its two employees, the sole shareholder and his son. The following statement appears at the end of the letter:
Finally, we would like to note that there is no requirement under the Act that different insurance policies that provide wage loss benefits coverage to employees be "grouped" together to qualify as a wage loss replacement plan for purposes of paragraphs 6(1)(a) and 6(1)(f).
It is not apparent what is meant by this statement, particularly as it applies with respect to paragraph 6(1)(a). The relevant part of that paragraph is the reference in subparagraph 6(1)(a)(i) to a "group sickness or accident insurance plan."
a)Would the CRA clarify what is meant by this statement as it applies with respect to paragraph 6(1)(a)?
b) Has the CRA changed its position as to what is required for an arrangement to be considered a group plan when the arrangement involves the employer acquiring individual insurance policies in connection with the provision of sickness or accident benefits to employees? If so, what is now required for such an arrangement to be considered a group plan?
Our reply is based on the CRA's long-standing position that an employer can provide group benefits under a plan via a single contract with an insurer or under individual contracts. For a particular plan to be considered a group plan it must provide benefits to more than one employee. Further, where there is more than one policy under a plan we would expect that the policies provide similar benefits to employees and that employee entitlements under the policies are documented; otherwise it may not be reasonable to consider that the benefits provided under each policy are under the umbrella of a single plan.
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Could the CRA provide an update on the status of IT-85R3, the proposed Interpretation Bulletin on health and welfare trusts? Also, does the CRA have any comments with respect to CALU's submission of Oct. 13, 2005, to Mr. Phil Jolie regarding the proposed Interpretation Bulletin?
In 2005, we provided a copy of draft IT-85R3 to CALU and to the CICA-CBA Joint Committee on Taxation. Since the Committee's public release of its submission on the draft, we have received numerous others. We appreciate all the comments, but given their volume and the various issued raised, we are not in a position to comment publicly. At this point we are taking a fresh look at IT-85R3 and will take into account all the submissions before the bulletin is released in its final form.
Where an employer provides post-retirement health and dental insurance benefits to retired employees, the employer may establish a trust for this purpose. The employer would make contributions to the trust, and the trust would pay all benefits.
It appears that such an arrangement is a retirement compensation arrangement (RCA) unless it falls within one of the exclusions. The only exclusion that is potentially applicable is for a group sickness or accident insurance plan. Since health and dental benefits are generally benefits payable as a result of sickness or accident, a group plan that provides such benefits should be considered a group sickness or accident insurance plan, notwithstanding that the plan is also a private health services plan (PHSP) for purposes of the Act.
In a letter dated May 5, 2005 (Document No. 2005-0121151E5), the CRA stated that a plan that provides health and welfare benefits to retired employees would not be considered an RCA. However, the CRA did not provide a rationale for this position.
Could the CRA confirm that an arrangement of the sort described above is a group sickness or accident insurance plan and hence is not an RCA?
We agree that the concept of a group sickness or accident insurance plan would not specifically exclude a PHSP. However, whether a particular PHSP is a group sickness or accident insurance plan would depend upon the terms and conditions of the particular plan.
It is also a question of fact whether a particular arrangement would be an "RCA". In general, a qualifying health and welfare trust that provides post-retirement health and welfare dental benefits under a plan of insurance would not be subject to the RCA rules.
The CRA appears to have inconsistent positions regarding the meaning of "insurance plan". This term is used in the expression "group sickness or accident insurance plan" in subparagraph 6(1)(a)(i), in paragraph 6(1)(f), and in the definition of "private health services plan" in subsection 248(1).
According to paragraph 7 of IT-428 (Wage Loss Replacement Plans), which discusses the meaning of "insurance plan" for purposes of paragraph 6(1)(f), if insurance is not provided by an insurance company, the plan must be funded:
It is to be noted that, while a plan must involve insurance, it is not necessary that there be a contract of insurance with an insurance company. If, however, insurance is not provided by an insurance company, the plan must be one that is based on insurance principles, i.e., funds must be accumulated, normally in the hands of trustees or in a trust account, that are calculated to be sufficient to meet anticipated claims. If the arrangement merely consists of an unfunded contingency reserve on the part of the employer, it would not be an insurance plan.
On the other hand, IT-339R2, which discusses the meaning of "private health services plan" (PHSP), does not state that a plan must be funded in order to be an insurance plan that is a private health services plan. In fact, paragraph 7 of the Interpretation Bulletin makes it clear that funding is not required. According to that paragraph, an arrangement under which an employer is required to reimburse its employees for the cost of medical or hospital care can qualify as a PHSP.
The elements set out by case law that must be present for there to be insurance do not include funding. These elements, which are listed in paragraph 3 of IT-339R2, are the following:
(a) an undertaking by one person,
(b) to indemnify another person,
(c) for an agreed consideration,
(d) from a loss or liability in respect of an event,
(e) the happening of which is uncertain.
What is the basis for the CRA's position in IT-428 that a plan that does not involve a contract with an insurer must be funded in order to be considered an insurance plan?
This question is similar to that asked at the 1995 TEI conference (Question 11). As noted then, distinguishing whether self-funded arrangements contain the requisite element of insurance presents a difficult challenge for the CRA. In that regard, the comments in IT-428 are intended to distinguish arrangements that are taxable under paragraph 6(1)(f) from self-funded arrangements that are arguably salary continuances. While we may consider a certain arrangement under which an employer reimburses its employees for the cost of qualifying PHSP expenses to be a plan of insurance, we are not prepared to extend similar treatment to self-funded group sickness or accident insurance plan.
CALU Comment: The question of whether a group short- or long-term disability plan is an insurance plan, and hence a group sickness or accident insurance plan, can be relevant in determining if EI premiums are payable in respect of plan benefits.
Where an individual is both a shareholder and an employee of a corporation, the tax treatment of certain benefits provided to the individual depends on whether the benefits are provided by virtue of the individual's status as a shareholder or an employee. For example, health and dental benefits are tax-free if regarded as employment benefits but not if regarded as shareholder benefits. Furthermore, the cost of providing the benefits is deductible to the corporation only if the benefits are employment benefits. The determination of whether benefits are provided by virtue of employment or shareholding is often difficult to make.
In a number of technical interpretation letters, the CRA has made general statements regarding this determination. However, the statements are not entirely consistent with each other, with the result that the CRA's position is unclear.
In Document No. 2003-0034505, the CRA states that there is a presumption that an employee-shareholder receives a benefit by virtue of his or her shareholding:
When a benefit is provided to a taxpayer who is both an employee and a shareholder of the corporation, there is a presumption that the benefit is made to the individual in his or her capacity as a shareholder. ... On the other hand, if it can be shown that the benefits are conferred on the shareholder-employee in his or her capacity as an employee, subsection 15(1) will not apply and the taxability of the benefits will generally be determined under the provisions applicable to employees.
This position establishes a high threshold for treating benefits provided to an employee-shareholder as employment benefits. Often, there will be nothing to show that benefits are conferred because the individual is an employee. There will merely be the fact that the benefits are conferred.
Other letters take a more pragmatic approach. These letters accept that, in cases where the only employees are shareholder-employees, benefits will be regarded as employment benefits if they are part of a reasonable remuneration package (see, for example, Document No. 2005-0115691E5).
What is the CRA's current position as to when benefits provided to shareholder-employees will be regarded as employment benefits, if all employees are shareholders or related to shareholders?
In and by itself, the fact that an individual is the only employee and shareholder of a corporation does not mean a benefit is received qua shareholder. We agree that a pragmatic approach to the determination is warranted and, generally, if it is reasonable to conclude that the benefit has been provided as part of a reasonable employee remuneration package we will consider it to be received qua employee.
The CRA has made a number of statements over the years regarding the application of the shareholder benefit rule in subsection 15(1) where a shareholder of a private corporation borrows money from a financial institution, and the corporation guarantees the loan or provides security for it (e.g., a mortgage over corporate property, or a collateral assignment of a corporate-owned life insurance policy). In these statements, the CRA has identified factors that it considers relevant in determining if the corporation has conferred a benefit on the shareholder.
These factors include:
(i) whether the shareholder deals at arm's length with the corporation;
(ii) whether there is evidence that the shareholder is unable to repay the loan when the corporation provides the support for the borrowing; and
(iii) whether the shareholder is required to pay a reasonable fee to the corporation for providing the guarantee or security.
a) What is the CRA's current position with respect to shareholder benefits when a corporation provides a guarantee or security as described above?
b) Specifically, in what circumstances will the provision of the guarantee or security result in a benefit and in what circumstances will there be a benefit if the lender realizes on the guarantee or security?
Where a shareholder of a corporation borrows money ("Loan") from a financial institution and the corporation guarantees the Loan and /or provides security as collateral to the Loan ("Guarantee"), the determination of whether or not the corporation has conferred a benefit on the shareholder can only be made following a review of all of the circumstances of a particular situation. We have no firm guidelines as to when we will assess a benefit. However, we will not assess a benefit in the situation where the shareholder is dealing at arm's length with the corporation and there is no evidence that the shareholder is, at the time the Guarantee is granted, unable to repay the Loan. This position was previously stated in the response to Question 62 at the 1986 CTF Revenue Canada Round Table, Question 24 at the 1991 CTF Revenue Canada Round Table and Question 41 at the "Insights Into The 1991 Revenue Canada Round Table discussion" which was sponsored by the Institute of Chartered Accountants of Ontario and held as part of the Bottom Line Trade Show in Toronto on July 29, 1992.
In the situation where the shareholder pays a reasonable fee to the corporation as consideration for the granting of the Guarantee, the Guarantee would not, in and by itself, give rise to a benefit. This position was previously stated in the response to Question 6 at the 1992 Manitoba Round Table.
In the situation where the corporation is called upon to honour the Guarantee, any payments that the corporation makes to the financial institution to fully discharge its obligation under the Guarantee, including the security realized by the financial institution, would generally constitute a benefit conferred on the shareholder under subsection 15(1). However, any amounts that the corporation recovered from the shareholder will reduce the benefit. This position was previously stated in the response to Question 62 at the 1986 CTF Revenue Canada Round Table, Question 15 at the 1990 APFF and Question 6 at the 1992 Manitoba Round Table.