Typically, when you receive a loan, it is not included in your income. The reason is that your receipt of the loan is offset by your obligation to repay it.
However, the situation may change if you receive a loan from a corporation in which you are a shareholder. In this case, the loan may be included in your income under the shareholder loan rule in the Income Tax Act.
In addition, if a person “connected” with you receives a loan from the corporation, it may be included in their income. The definition of “connected” is fairly complex, but it includes non-arm’s length persons like your spouse, children, parents, grandchildren and so on. It can also include another corporation − for example, if you control both the lending corporation and the another corporation that receives the loan.
Fortunately, there are some exceptions where the rule does not apply and thus the loan is not included in your income. The most common exceptions are as follows.
Exception 1: Corporation’s lending business
The rule does not apply to a loan you received in the ordinary course of the corporation’s business of lending money where, at the time the loan was made, bona fide arrangements were made for repayment of the loan within a reasonable time.
Note that the corporation does not have to be a bank or financial institution, as long as you can show that it is in the business of lending money (even if it has another business).
Exception 2: Certain employees
If you are also an employee of the corporation, you could qualify for this exception.
It can apply if you are not a “specified employee”. In general terms, you will not be a specified employee if you and non-arm’s length persons (mostly meaning your close relatives) do not own 10% or more of any class of shares in the corporation.
The exception can also apply if the loan was used to acquire a residential home, treasury shares from the corporation or a related corporation, or a motor vehicle to be used in your employment. In these cases, the exception can apply even if you are a specified employee.
Exception 3: Repayment of loan within one year from the end of the tax year
This exception applies if you repay the loan within one year after the end of the taxation year of the corporation in which the loan was made. A corporation can have an off-calendar year taxation year or use the calendar year as its taxation year.
Example
You are a shareholder of a corporation. The corporation’s taxation year ends on March 31 of each calendar year.
You receive a loan from the corporation on June 1, 2022, which is in the corporation’s taxation year ending on March 31, 2023. If you repay the loan by March 31, 2024, this exception can apply.
Caveat: The repayment must not be part of a series of loans and repayments.
Repayment of loan (other than under Exception 3)
If you include the loan under the shareholder loan rule because none of the exceptions applies, you get an offsetting deduction in the year that you repay it. Again, the caveat is that the repayment must not be part of a series of loans and repayments. For example, if you take out a loan, repay it later, the corporation re-lends to you, you repay that loan, and so on, you might not get the deduction upon repayment.
Possible deemed interest benefit
If the shareholder loan rule does not apply because you fall within an exception, you may still have to include a deemed interest benefit in your income. This rule does not apply if you pay at least the prescribed rate of interest during the year in question, either in the year or by January 30 of the following year. The prescribed rate is set quarterly and is typically low because it is based on the yield of 90-days federal treasury bills.
The prescribed rate was 1% from July 2020 through June 2022. For July to September 2022, it is 2%. Given that interest rates are now rising in response to inflation (due to the amount of money poured into the economy by the government during the pandemic), it will likely be higher starting October 2022.
This deemed-interest rule also does not apply if the interest rate on the loan is at least equal to the rate that a lender would charge an arm’s length person for a loan.
Example
You receive a $100,000 loan from a corporation on January 1, Year 1.
You do not include the loan in income because you fall within on the exceptions to the shareholder loan rule.
Assume the prescribed rate of interest throughout Year 1 is 2%.
If you pay no interest, your benefit will be $2,000.
If you pay 1% interest by January 30 of Year 2, your benefit will be $1,000.
And of course, if you pay 2% or more on the loan by January 30 of Year 2, you will have no benefit included in your income.