CRA recently released a letter which discusses various issues relating to a non-interest bearing loan provided to a charitable foundation. A taxable Canadian corporation provided a loan to a related Foundation (a Canadian registered charity) which did not carry a stipulated rate of interest. The question was whether the Corporation should charge interest at a prescribed rate to the Foundation. It was found that Section 69(1)(a) of the Income Tax Act may deem the holder to acquire the loan at a cost that is less than the principal amount. Here is an excerpt from the letter:
"You indicate that the Loan does not carry a stipulated rate of interest. A debt obligation that does not carry a stipulated rate of interest is a prescribed debt obligation under paragraph 7000(1)(a) of the Income Tax Regulations (the “Regulations”). Accordingly, pursuant to subsection 12(9) of the Act, Canco may be required to accrue interest on the Loan.
Whether any accrual will be required will depend on paragraph 7000(2)(a) of the Regulations. This paragraph would generally require Canco to compute deemed interest at a rate that would result in the present value of the maximum of all payments under the Loan being equal to the cost of the Loan to Canco. Where the amount payable on maturity of the Loan is equal to the cost of the Loan to Canco, paragraph 7000(2)(a) of the Regulations should not deem any interest to accrue. Where the cost of the Loan is less than the amount payable at maturity, there will be a deemed accrual under paragraph 7000(2)(a) of the Regulations.
However, because the Loan was made between two non-arm’s length parties, paragraph 69(1)(a) of the Act may apply to reduce the cost of the Loan to Canco. If the Loan is not repayable at the demand of Canco, it is possible that the fair market value of the Loan could be less than the amount advanced by Canco under the Loan. If that is the case, then paragraph 69(1)(a) of the Act could deem Canco to have acquired the Loan at a cost equal to the fair market value of the Loan, triggering the deemed accrual under paragraph 7000(2)(a) of the Regulations referenced above. A reduction in the cost of the Loan under paragraph 69(1)(a) of the Act would also have consequences for the calculation of any eventual gain or loss of Canco on the disposition of the Loan, subject to the potential application of subsection 52(1) of the Act in respect of any deemed accrual under subsection 12(9) of the Act."
The full CRA letter can be accessed here.
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Mark Blumberg is a partner at the law firm of Blumberg Segal LLP in Toronto and works almost exclusively in the areas of non-profit and charity law.