IMP /R3 Debt incurred without interest or at a reduced interest rate Date of publication: September 30, 1993

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1 INTERPRETATION AND ADMINISTRATIVE BULLETIN CONCERNING THE LAWS AND REGULATIONS Income Tax IMP /R3 Debt incurred without interest or at a reduced interest rate Date of publication: September 30, 1993 Reference(s): Taxation Act (R.S.Q., c. I-3), sections 1, 37, 37.1, 64, 87.2, 111, 119.1, 160, to and Regulation respecting the Taxation Act (R.R.Q., 1981, c. I-3, r.1, as amended), sections 487.2R1, 487.2R2 and 487.4R1 This bulletin cancels and replaces bulletin IMP /R2 of July 31, This bulletin sets forth the policy of the Ministère du Revenu concerning the deemed benefit received in certain cases where debts are contracted by reason of an office or employment, services provided or to be provided by a corporation carrying on a business of providing personal services, or as a shareholder of a corporation. APPLICATION OF THE ACT 1. Section of the Taxation Act (the Act ) provides that an individual or a corporation carrying on the business of providing personal services is deemed to receive a benefit in a taxation year, when a person or partnership contracts a debt by virtue of the individual s current or planned office or employment, or by virtue of services provided or to be provided by the corporation carrying on the business of providing personal services. 2. The amount of the benefit to be included in computing the income of an individual or a corporation carrying on a business of providing personal services, as the case may be, is obtained by subtracting the amount computed pursuant to article 3 below from the aggregate of the interest in respect of each of these debts computed at the prescribed rate (see article 27 below) in respect of the debt for the period of the year in which it was unpaid, and the interest paid or payable for the year in respect of each such debt by: (a) a person or partnership that employed or planned to employ the individual; (b) a person or partnership to whom or which or for whom or which the corporation provided or was to provide services; or

2 (c) a person who was not debtor for the debt and who was connected with the person or partnership referred to in (a) above, or was not dealing at arm s length with the person or partnership referred to in (b) above. 3. The amount referred to in 2 above is the aggregate of (a) the interest for the year paid on each such debt not later than 30 days after the end of the year; and (b) the portion of the interest paid or payable for the year in respect of each such debt by a person or entity referred to in 2(a), 2(b) or 2(c) above that is reimbursed by the debtor in the year or within 30 days after the end of the year to the person or entity who made the payment referred to in that paragraph. 4. Therefore, the debtor s reimbursement of interest paid or payable on such debts reduces the amount of the taxable benefit determined in 2 above. 5. The matter of determining if a debt was contracted by an individual by virtue of an office or employment is a question of facts which must be analyzed according to the circumstances proper to each case. In cases where section of the Act does not apply, the individual may have to include in computing his income, under section 37 of the Act, the value of certain benefits. 6. Section of the Act provides that a person who is not a corporation resident in Canada or a partnership every member of which is not such a corporation is deemed to receive a benefit in a taxation year when he or it contracts a debt with a corporation by virtue of the fact that he or it is a shareholder thereof, that he or it is connected with such a shareholder or that he or it is a beneficiary or a member of a trust or a partnership that is such a shareholder. 7. Section of the Act also provides that a person or a partnership referred to in 6 above is deemed to receive a benefit in a taxation year when he or it contracts a debt with a corporation related to a corporation of which he or it is a shareholder or with a partnership of which the corporation or a corporation related to it is a member. 8. The amount of the benefit mentioned in 6 or 7 above to be included in computing the income of a person or a partnership referred to in 6 above, as the case may be, is obtained by subtracting the interest paid for the year in respect of each such debt not later than 30 days after the end of the year or on December 31, 1982, whichever is later, from the interest in respect of each such debt, computed at the prescribed rate (see article 27 below), in respect of the debt for the period of the year in which it was unpaid. Home Purchase Loan or Home Relocation Loan 9. Under section of the Act, for the purposes of computing the benefit under section of the Act in a taxation year in respect of a debt contracted for a home purchase loan or a home relocation loan and for the purposes of section of the Act, the amount of the aggregate of all interest on all such debts computed at the prescribed rate (see article 27 below) on each such debt for the period in the year during which it was outstanding shall not exceed:

3 (a) the amount of interest that would have been determined thereunder if it had been computed at the rate of 8% in the case of a debt contracted before May 1, 1987; (b) in any other case, the amount of interest that would have been determined thereunder if it had been computed at the prescribed rate (see article 27 below) in effect at the time the debt was contracted. 10. Under section of the Act, for the purposes of sections to of the Act, other than paragraph b of section of the Act (see 23(b) below), where a debt, other than a prescribed debt, contracted for a home purchase loan or a home relocation loan of an individual has a term for repayment exceeding five years, the balance outstanding on the debt on the date that is five years from the day the debt was contracted or was last deemed by section of the Act to have been contracted is deemed to be a new debt contracted for a home purchase loan on that date. 11. When a debt or portion of a debt is deemed to be a new debt contracted for a home purchase loan in accordance with the mechanism mentioned in 10 above, the benefit from a debt contracted for a home purchase loan or a home relocation loan must be determined, for every five year loan period, including the initial period, in relation to the prescribed rate (see article 27 below) in effect at the beginning of every period. 12. Section of the Act provides that subject to paragraph f of section of the Act (computation of the taxable income of an individual referred to in the second paragraph of section of the Act) and paragraph d of section of the Act (computation of the taxable income of a foreign researcher referred to in section of the Act), an individual who has, by virtue of sections to of the Act, included an amount in computing his income for the year in respect of a benefit received by him in respect of a home relocation loan, may deduct an amount equal to the least of (a) the amount of the benefit that would have been deemed to have been received by the individual under sections to of the Act in the year if those sections had applied only in respect of the home relocation loan; (b) the amount of interest for the year that would be computed at the prescribed rate (see article 27 below) referred to in section of the Act in respect of the home relocation loan if that loan were in the amount of $25,000 and were extinguished on the earlier of i. the day that is five years after the day on which the home relocation loan was made, and ii. the day on which the home relocation loan was extinguished; and (c) the amount of the benefit he is deemed to have received under sections to of the Act. 13. Since the deduction provided for in the new version of section of the Act is limited to the first five years of a home relocation loan, a debt or portion of a debt that is deemed to be a new debt contracted for a home purchase loan in accordance with the mechanism described in 10

4 above, will be dealt with in the same manner as a debt contracted for a home purchase loan at the end of its first five year period and the benefit received from that loan will be taxable. MEANING OF CERTAIN EXPRESSIONS Person Connected with a Shareholder 14. For the purposes of section of the Act, a person is connected with a shareholder of a corporation if he is not dealing at arm s length with the shareholder and if he is not a foreign affiliate of the corporation or a foreign affiliate of a person resident in Canada who is not dealing at arm s length with the corporation. Personal Services Business 15. Under section 1 of the Act, this expression means a personal service business carried on by a corporation in a taxation year where an employee who provides services on behalf of the corporation, called an incorporated employee, or a person related to an incorporated employee is a specified shareholder of the corporation and where the incorporated employee may be reasonably classed, disregarding the corporation, as an employee of the person or partnership to whom or which he provided the services unless (a) the corporation employs in the business throughout the year more than five full-time employees; or (b) the amount received or receivable by the corporation in the year for the services provided is paid or payable by a corporation with which it is associated during that year. Home Purchase Loan 16. Under section of the Act, for the purposes of sections to of the Act, the expression home purchase loan means that portion of any debt contracted by an individual in the circumstances described in sections and of the Act that is used to acquire, or to repay a debt that had been contracted to acquire, a dwelling or a share of the capital stock of a cooperative housing corporation acquired for the sole purpose of acquiring the right to inhabit a dwelling owned by the corporation, where the dwelling is for the habitation of any of the persons contemplated in the second paragraph of this article, or that is used to repay a debt contracted to acquire such a dwelling or share, or to repay a home purchase loan. The persons referred to in the preceding paragraph are the following: (a) the individual by virtue of whose office or employment the debt is contracted; (b) a specified shareholder of the corporation by virtue of whose services the debt is contracted; (c) a person related to a person described in (a) or (b) immediately preceding.

5 Specified Shareholder 17. Under sections 1, and of the Act, a specified shareholder of a corporation in a taxation year is a taxpayer who owns, directly or indirectly, at any time in the year, not less than 10% of the issued shares of any class of the capital stock of the corporation or of any other corporation that is related to the corporation. RULES APPLICABLE TO INDIVIDUALS 18. An individual receives a benefit when a person or a partnership contracts a debt by virtue of the individual s current or planned office or employment and the debt contracted bears interest at a rate less than the prescribed rate (see article 27 below). This benefit computed in accordance with section of the Act will be included in computing the individual s income under section 37.1 of the Act. 19. An individual who contracts a debt with a corporation, by virtue of the fact that he is a shareholder thereof, that he is connected with such a shareholder, that he is a beneficiary of a trust that is such a shareholder, or member of a partnership that is such a shareholder, receives a benefit where the debt contracted bears interest at a rate less than the prescribed rate (see article 27 below). That benefit computed in accordance with section of the Act will be included in computing the income of the individual as a shareholder of the corporation under section 111 of the Act, by reason of section of the Act. RULES APPLICABLE TO CORPORATIONS CARRYING ON A PERSONAL SERVICES BUSINESS 20. A corporation carrying on a personal services business receives a benefit where a person or a partnership contracts a debt by reason of the services provided or to be provided by the corporation and the debt contracted bears interest at a rate less than the prescribed rate (see article 27 below). That benefit computed in accordance with section of the Act will be included in computing the income of the corporation under section 87.2 of the Act. RULES APPLICABLE TO PARTNERSHIPS 21. A partnership every member of which is not a corporation resident in Canada, that contracts a debt with a corporation by virtue of the fact that it is a shareholder thereof, that it is connected with such a shareholder, that it is a beneficiary or a member of a trust or partnership that is such a shareholder, receives a benefit where the debt contracted bears interest at a rate less than the prescribed rate (see article 27 below). That benefit computed in accordance with section of the Act will be included in computing the income of the partnership as a shareholder of the corporation under section 111 of the Act, by reason of section of the Act. SPECIFIC CASE - SHAREHOLDER CORPORATION 22. Where a shareholder corporation contracts a debt with another corporation at an interest rate less than a reasonable rate, this results, in most cases, in a benefit for the corporation that must be included in computing its income under section 111 of the Act.

6 Where one or the other of these corporations contracts the debt in the course of carrying on its business, though, and that a very low rate of interest or a rate equal to nil seems reasonable in the circumstances, the Ministère du Revenu considers that no benefit is granted under section 111 of the Act. EXCLUDED DEBT (Section of the Act) 23. Articles 1, 6 and 7 do not apply in respect of a debt or the portion of a debt (a) that is included in computing the income of a person or partnership under Part I of the Act; or (b) on which the interest is paid or payable to the creditor only by the debtor and in respect of which the rate of interest is not lower than the rate which, in view of the circumstances and the terms and conditions of the debt, would have been agreed upon, when the debt was contracted, between the parties who were dealing at arm s length, if the loan of money had been part of the creditor s normal business and if neither of the parties contracted the debt by virtue of an office or employment, or by virtue of the fact that a person or partnership is a shareholder. BENEFIT DEEMED TO BE INTEREST 24. Under section of the Act, for the purposes of sections 64 and 160 of the Act, any benefit deemed to be received in a taxation year under section or of the Act is also deemed to be interest paid in the year and payable in respect of the year by the debtor in accordance with a legal obligation to pay interest on a loan. 25. The value of the benefit which must be included in computing the income may be deducted by virtue of sections 64 and 160 of the Act in whole or in part, in proportion to the part of the debt contracted that is used by the debtor to derive income from a business or property. NON-RESIDENT 26. Where a person is not resident in Canada and is employed in Québec or was previously employed in Québec, and a person or partnership contracted a debt by virtue of that employment, the deemed benefit received pursuant to section of the Act will be included in computing his income earned in Québec and in Canada pursuant to sections 26, 37.1, 1089 and 1090 of the Act. PRESCRIBED RATE 27. For the purposes of articles 2, 8, 9, 11, 12 and 18 to 21 above and subject to article 28 below, the prescribed rate is equal: (a) subject to (b) below, to the rate mentioned in Schedule I to this bulletin that is established by the Income Tax Regulations (Consolidated Regulations of Canada, 1978, c. 945, as amended) (the federal regulations ); (b) where a debt is contracted before January 1, 1974, and the interest rate is less than 8%:

7 i. to the annual interest rate payable on that debt, where the rate cannot be determined again after December 31, 1973; or ii. to the annual interest rate payable on that debt for the period preceding the day on which the rate may be determined again for the first time after April 30, 1987, where the rate of the debt may be determined again after December 31, 1973, but cannot be determined again before May 1, Where an individual benefits from an employer loan under Phases III, IV and V of the Corvée-Habitation programme adopted under the Act to promote housing construction (R.S.Q., c. C-64.01), the annual rate of interest is 9.5%, to the extent that the loan gives entitlement to the benefits provided for by that programme.

8 SCHEDULE I Prescribed interest rate under section 4301 of the federal regulations as of January 1, 1984 YEAR JANUARY 1 TO MARCH 31 APRIL 1 TO JUNE 30 JULY 1 TO SEPTEMBER 30 OCTOBER 1 TO DECEMBER % 10% 11% 13% % 10% 10% 10% % 11% 10% 9% % 8% 8% 9% % 9% 9% 10% % 12% 13% 13% % 13% 14% 14% % 11% 10% 9% % 8% 7% 6% % 7% 6% 5% % 4% 6% 7% %