Dear Sirs:
Re: Subsections 12(4) and 78(1) of the Income Tax Act (the "Act"
This is in reply to your letter of July 26, 1991 wherein you request our views concerning the interaction of subsections 12(4) and 78(1) of the Act in the,following hypothetical situation:
"The shareholder owns all of the issued and outstanding common shares of a Canadian-controlled private corporation. On January 31, 1990 the shareholder loaned $100.000.00 to the corporation. The debt bears interest on demand at 10% per annum. The shareholder records interest income on the cash basis whereas the corporation accrues and expenses the interest annually".
Subsection 12(4) of the Act requires that the shareholder include in his income for the 1991 taxation year the interest that accrued to him to the end of anniversary day (January 30, 1991).
Subsection 78(1) of the Act would apply, if the interest remains unpaid at end of the second taxation year of the corporation following the taxation year in which the interest expense occurred and an agreement in prescribed form was not filed. As a result paragraph 78(1)(a) of the Act requires the amount of the unpaid interest at the end of that second taxation year to be included in the corporations income for the third taxation year following the year in which the interest expense was incurred.
The inclusion of an amount of unpaid interest expense in the corporation's income pursuant to paragraph 78(1)(a) of the Act does not preclude the inclusion in the shareholder's income of accrued interest pursuant to subsection 12(4).
We trust our comments will be of assistance to you.
Yours truly,
for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch