Principal Issues: Whether a "specified right" exists for the purposes of subparagraph 15(2.16)(c)(ii) where the security may only be used for repayment of the debt.
Position: No
Reasons: Contextual application of the definition "specified right" in subsection 18(5), as supported by the Department of Finance explanatory notes.
2017 CPA Alberta Tax Conference
Question 11 – Back-to-back shareholder loans in a domestic context
The Explanatory Notes to subsection 15(2.16) indicate that “it is intended that a specified right will not exist if it is established that all of the net proceeds from exercising the right…must be applied to reduce the shareholder debt”. Absent such an interpretation, it appears that any use of corporate assets as security for a personal debt of a shareholder, including debt payable to an arm’s length party on fully arm’s length terms, could be subject to inclusion in the shareholder’s income on the same basis as if it were advanced to him by the corporation.
1. Does the CRA consider that the technical phrasing of subsection 15(2.16) and the definition of “specified right” in subsection 18(5) support the interpretation that, where the security offered by the corporation may be used only for repayment of the arm’s length debt, the shareholder will not be exposed to such an income inclusion?
2. What if the shareholder has more than one borrowing from the same creditor, where the corporate assets secure all of the loans?
CRA Response
The back-to-back shareholder loan rules in subsections 15(2.16) to (2.192) are intended to ensure that the application of subsection 15(2), among other rules, is not avoided where a corporation provides debt funding to its shareholder indirectly through one or more intermediaries.
As with the other provisions of these rules, the “specified right” rule in subparagraph 15(2.16)(c)(ii) is generally meant to capture situations in which the corporation itself is the real source of the funding to the shareholder and not the intermediary. As such, where a security interest in the assets of the company is tantamount to putting assets in the hands of the intermediary for its general use, the shareholder loan rules will ordinarily apply. Where, on the other hand, the security interest is a typical commercial security feature of an arm’s length lending arrangement, such that the assets that are the subject of the security can only be used to repay the debt and any accrued interest, the shareholder loan rules should generally not apply.
1. Applying the contextual modifications that are necessary to give effect to the reference in subsection 15(2.192) to the “specified right” definition in subsection 18(5), where a financial institution lends money on commercial terms to an individual that is a shareholder of a corporation, the corporation provides a security interest in its property to the lender, and such property can only be used in the event of default on the loan as a means of repaying amounts owing by the debtor under the lending agreement, then the security interest would not ordinarily be considered a “specified right”.
2. A security interest granted by a corporation to a creditor that may be used, in the event of default, to repay more than one debt owing by a shareholder of the corporation to that creditor would not, in and of itself, be considered to be a “specified right”.
Dave Beaulne
2017-070390
September 14, 2017