Shareholder Loans: Does TOSI Prevent a Deduction on Repayment?

The income inclusion for a shareholder loan under subsection 15(2), which may apply if the loan is not repaid by the date specified in subsection 15(2.6), can normally be offset by a paragraph 20(1)(j) deduction when the loan is repaid after that date. However, under one interpretation of that paragraph, this deduction would not be available if the shareholder loan is considered split income. Note that paying back the loan within the time permitted under subsection 15(2.6) will avoid the subsection 15(2) inclusion.

Although individual taxpayers who are already paying tax at the highest marginal rate may overlook the TOSI regime, this outcome suggests that TOSI may affect high-rate taxpayers as well. As long as one's shareholder loan could be caught as split income, whether a person is already paying the high rate of tax is irrelevant—the paragraph 20(1)(j) deduction might not be available.

Consider a shareholder whose circumstances cannot satisfy any of the conditions of the definition of "excluded amount" in subsection 120.4(1). If the shareholder takes a loan from a corporation and does not repay it within the time permitted under subsection 15(2.6), the amount may be taxable under subsection 15(2), and it would be considered split income pursuant to subparagraph (a)(ii) of the definition of "split income" in subsection 120.4(1), and be subject to tax at the top marginal rate. This subsection 15(2) inclusion is offset by a paragraph 20(1)(ww) deduction for split income, which ensures that split income is effectively taxed only pursuant to subsection 120.4(3).

The question is whether the paragraph 20(1)(j) deduction will be available. A deduction is available for

such part of any loan or indebtedness repaid by the taxpayer in the year as was by virtue of subsection 15(2) included in computing the taxpayer's income for a preceding taxation year (except to the extent that the amount of the loan or indebtedness was deductible from the taxpayer's income for the purpose of computing the taxpayer's taxable income for that preceding taxation year) [emphasis added].

The issue is the meaning of the italicized phrase providing a carve-out from the deduction: does it refer to division C deductions, or to amounts deductible in computing division B income? Under the first interpretation, the paragraph 20(1)(j) deduction can be taken as usual; but under the second interpretation, the paragraph 20(1)(j) deduction is denied, since a deduction has been taken under paragraph 20(1)(ww).

Several arguments support the first interpretation:

  • The "from" in the phrase "deductible from the taxpayer's income" may be taken to suggest that one first calculates division B income, and then subtracts amounts from that in order to arrive at taxable income.
  • Subsection 112(1) uses a similar phrasing to provide a division C deduction for certain intercorporate dividends.
  • The common way to refer to deductions in computing division B income is different; for example, "in computing a taxpayer's income" (see, for example, subsections (8)(1) and 20(1)).
  • The CRA's opinion implies that the carve-out from the paragraph 20(1)(j) deduction only applies to corporate borrowers (see Interpretation Bulletin IT-119R4 (Archived), "Debts of Shareholders and Certain Persons Connected with Shareholders," August 7, 1998, at paragraph 30(a)). Could it be that the carve-out, and the associated CRA comment, is a holdover from the pre-1972 law when (as one reader has reported) shareholder loans were treated as dividends, and certain dividends were deductible under division C? In other words, the carve-out could be an historical relic with no application in the present Act.

Other arguments support the second interpretation:

  • The italicized phrase would be a highly unusual way to refer to division C deductions. The common ways to refer to division C deductions are "in computing the taxable income" (for example, in subsections 110.2(2), 110.6(2), and 110.6(2.1)) or "for the purpose of computing the taxable income" (for example, in subsections 110(1), 110.1(1), and 111(1)).
  • If the italicized phrase is to be limited to amounts that are deductible in computing taxable income, the reference to the taxpayer's income would seem to be superfluous.
  • The phrase "deductible from the taxpayer's income" does not occur only in division C; subsection 138(6) of division F contains approximately this phrasing. Hence, the italicized phrase may not necessarily refer to division C deductions.
  • The word "income" can sometimes refer to gross income rather than net income, as in "for the purpose of earning income" in subparagraph 20(1)(c)(i).

Until there is legislative clarification, cautious tax advisers may wish to suggest that taxpayers avoid this potential pitfall by paying back shareholder loans quickly enough to avoid the subsection 15(2) inclusion.

Martin Lee
Kakkar CPA Professional Corporation, Vaughan, ON

Canadian Tax Focus
Volume 9, Number 2, May 2019
©2019, Canadian Tax Foundation