New Back-To-Back Shareholder Loan Rules

Mr. Big is a very successful businessman and has accumulated a significant amount of retained earnings in his company, BigCo. BigCo invests its retained earnings primarily in deposits and investments held by BigCo’s commercial bank, First Bank. Instead of taking money out of his company to buy a new home (and which would require the payment of a significant amount of taxes which Mr. Big deplores), Mr. Big has arranged for personal mortgage financing from First Bank.

In order to reduce the interest rate on his mortgage with First Bank, Mr. Big has arranged for BigCo to pledge its deposits and investments held with the bank as additional collateral security on his home mortgage from First Bank. On the advice of his accountants, Mr. Big pays a guarantee fee to BigCo for its provision of collateral security on Mr. Big’s mortgage with First Bank.

Mr. Big is pleased with this arrangement because his accountants have always warned him that taking a loan from BigCo and not repaying it by the end of the year following the year the loan was taken results in an income inclusion to him and a significant tax bill. Mr. Big has not taken any loans from BigCo so such provision should not apply to him, right? Well, not really!

The Department of Finance announced new back-to-back shareholder loan rules in the 2016 Federal Budget released March 22nd 2016 that applies to loans or indebtedness that is outstanding on March 22^nd 2016 or is incurred after March 21st, 2016 and which is aimed at certain indirect loans made by a company to a shareholder of the company through an intermediary that circumvents the shareholder loan rules.

These new provisions apply where:

(I) a “Shareholder” has a debt or obligation (the “Shareholder Loan”) to pay an amount to an Intermediary and the Intermediary has a debt or obligation (the “Intermediary Loan”) to pay an amount to a person (the “Ultimate Lender”) that meets one of the following conditions:

1. 1. 1. The Ultimate Lender’s recourse with respect to the Intermediary Loan owing by the Intermediary is limited to the Intermediary’s Shareholder Loan with the Shareholder,

OR

1. 1. 2. It can reasonably be concluded that all or a portion of the Shareholder Loan was entered into or permitted to remain outstanding because all or a portion of the Intermediary Loan was entered into or permitted to remain outstanding.

OR

(II) the Intermediary has a “Specified Right” in respect of a particular property and the existence of the Specified Right is required under the terms and conditions of the Shareholder Loan or it can reasonably be concluded that the Shareholder Loan was entered into or permitted to remain outstanding because the Specified Right was granted or expected to be granted.

A Specified Right in respect of property means a right to mortgage, assign, pledge or in any way encumber the property in order to secure payment of an obligation or to use, invest, sell or otherwise dispose of the property.

This provision will apply where:

(I) First Bank has a debt or obligation to pay an amount to BigCo and either:

1. 1. 1. recourse with respect to all or a portion of the bank’s obligations to BigCo in regards to BigCo’s deposits and investments held with the bank is limited to First Bank’s mortgage loan to Mr. Big,

OR

1. 1. 2. it can reasonably be concluded that all or a portion of First Bank’s mortgage loan to Mr. Big was entered into or was permitted to remain outstanding because of BigCo’s deposits and investments with First Bank were made or permitted to remain outstanding.

OR

(II) First Bank has a right to mortgage, assign, pledge, or in any way encumber BigCo’s deposits and investments held to secure payment of Mr. Big’s Shareholder Loan owing to the bank or has a right to use, invest or sell the deposits and investments held.

If any of these conditions apply, Mr. Big will be deemed to have received a loan from BigCo, and may result in the loan being included in computing his income under the shareholder loan and which would trigger a significant tax liability to Mr. Big, unless the arrangements between BigCo and First Bank in regards to BigCo’s deposits and investments held with First Bank are changed so that they are no longer caught in these new rules.

Mr. Big should consult with his accountants to review whether these new back-to-back shareholder loan rules apply to him and if they do, to determine what can be done to mitigate their effects before it is too late.