If you receive a loan from your employer with an interest rate below the “prescribed rate” of interest, you must normally include in your employment income an imputed interest benefit, under section 80.4 of the Income Tax Act.
The amount of the benefit to be included in your income for a taxation year is:
- the prescribed rate of interest applied to the principal amount of the loan outstanding during the year, minus
- any interest you pay on the loan in the year or by January 30 of the following year.
The prescribed rate of interest is set for each quarter of each year and is based on 90-day Federal treasury bill rates. For the first quarter of 2019, the rate was 2%. The amount of the benefit can therefore vary from quarter to quarter and year to year as the loan remains outstanding.
However, if the loan is a “home purchase loan”, the prescribed rate of interest at the time of the loan is effectively a cap, serving as the maximum interest rate that will apply for each of the first five years of the loan. In other words, even if the prescribed rate increases in a subsequent quarter, the benefit for a year will be based on the lower prescribed rate that applied at the time of the loan. On the other hand, if the rate subsequently decreases below the prescribed rate at the time of the loan, such that the benefit in a year is lower than the benefit that would apply using the cap rate, then the lower rate will apply.
If the home purchase loan remains outstanding for more than five years, the new cap rate will be the prescribed rate at the five-year mark.
You receive a $200,000 interest-free home purchase loan from your employer on January 1, when the prescribed rate is 2%. The rate remains at 2% for the first two quarters but increases to 3% for the last two quarters of the year. You do not repay any of the principal.
Your deemed benefit for the year will be capped at 2% of the principal amount of the loan, or $4,000.
On the other hand, if the rate decreased to 1% for the last two quarters, your benefit for the year would be 2% x $200,000 x ½ (for first half of year) plus 1% x $200,000 x ½ (second half of year), totalling $3,000.
A home purchase loan is a loan used to acquire a dwelling in which you or a related person will live. It does not include a loan used to acquire a rental property to earn rental income.