There are various employment benefits that are taxable for employees. One such benefit occurs where an employee receives a no or low-interest loan from their employer, or more particularly, a loan with interest lower than the “prescribed rate” under the Income Tax Act.
The general rule provides that if you receive a loan from your employer, you will have a taxable benefit equal to the prescribed rate of interest on the principal amount of the loan, minus any interest you actually pay on the loan in the year or within 30 days after the year. (Right now the prescribed rate is just 1%.)
The interest calculations are rounded off without compounding.
I receive a $100,000 loan from my employer on January 1, Year 1 at 1% interest. The prescribed rate of interest for the first six months of Year 1 is 2% and it is 3% for the last six months. I pay the 1% interest on the loan by January 30, Year 2.
For the first six months of Year 1, I will have a taxable benefit of (2%-1%) x $100,000 x ½ (for half of the year), or $500. For the last six months, the taxable benefit will be (3%-1%) x $100,000 x 1/2 or $1,000.
I will have a total taxable benefit of $1,500 included in my income in Year 1.
Home purchase loans
A special rule applies if you use the loan to acquire a home in which you will live (it does not apply if you use the loan to buy an investment property that you rent out).
Basically, the maximum taxable benefit will be based on the lower of the prescribed rate of interest at the time of the loan and the prescribed rate that applies during the relevant year (some modifications may apply).
Assume the same facts as the above example, except that the $100,000 loan was used to acquire your home.
Since it is a home purchase loan, your taxable benefit is based on the 2% prescribed rate as of January 1, Year 1, and is not increased for the last six months.
Therefore, your taxable benefit for Year 1 will be (2%-1%) x $100,000, or $1,000.
The original home purchase loan rule applies for the first five years of the loan. After the fifth year, the prescribed rate of interest at that time becomes the new limit that applies for years 6 through 10.
Assume the same facts as above, except the prescribed rate of interest on January 1, Year 6, is 3% but increases to 4% for the last six months of the year. You pay the 1% interest on the loan for Year 6 on time.
The benefit will equal (3%-1%) x $100,000, or $2,000.