The CRA issues a new ‘Income Tax Folio’ on How Shareholder Loans and Debts are Treated

Income Tax Folio S3-F1-C1 Shareholder Loans and Debts replaces and cancels Interpretation Bulletin IT-119R4

In April 2025, the Canada Revenue Agency (CRA) issued the Income Tax Folio S3-F1-C1, Shareholder Loans and Debts, which can be relied upon as the accurate summary of the CRA’s interpretation regarding subsection 15(2) of the Income Tax Act (ITA) and its related provisions. This Folio replaced and cancelled the long-standing Interpretation Bulletin IT–119R4, Debts of Shareholders and Certain Persons Connected with Shareholders, which was issued back in 1998.

Loan or debt by virtue of shareholding

In a nutshell, subsection 15(2) generally requires that a person who receives a loan or incurs a debt from a corporation by virtue of shareholding must include the amount of the loan or debt in income for the tax year. However, there are a number of qualifications and exceptions which will be discussed further below.

Subsection 15(2) intends to cast a wide net to capture the scenarios that are not limited to where the corporation directly lends money to its shareholders, but also include where the loan is provided or the indebtedness is incurred due to the shareholding of related parties.

The person who receives a loan or incurs a debt is the borrower or debtor, and the corporation is the lender or creditor. A loan is where the lender gives money directly to the borrower, and debt is where the creditor makes a payment to a third party on behalf of the debtor or advances a future payment, such as salary or dividend, to the debtor.

The borrower or debtor is not limited to the shareholder of the corporation but can also be someone who does not deal at arm’s length with the shareholder such as (i) a spouse or a common-law partner of the shareholder, or (ii) a member of a partnership, or a beneficiary of a trust, that was a shareholder of the corporation.

However, a corporation resident in Canada or a partnership whose members are corporations resident in Canada is excluded, meaning the loan or debt is not included in income. A non-resident of Canada is also excluded because the amount of loan or debt is deemed to be a dividend paid to the non-resident and thus subject to withholding tax.

The lender or creditor is not limited to the corporation of which the borrower or debtor is a shareholder but can also be (i) related to another corporation of which the borrower or debtor is a shareholder, or (ii) a partnership of which the corporation that the borrower or debtor is a shareholder is a member.

Loans made in the ordinary course of the lender’s business of lending money or debts incurred in the ordinary course of the creditor’s business

Loans made in the ordinary course of the lender’s business of lending money are excluded from being included in the borrower’s income. There are two conditions underlying this exclusion: (i) the lender is in the business of lending money, e.g. a bank, and (ii) the loan is made in the lender’s ordinary course of business. Both conditions are determined based on the facts.

Debts incurred in the ordinary course of the creditor’s business are similarly excluded from being included in the debtor’s income, e.g. trade debts arising from the sale of goods or services between the creditor and debtor.

Moreover, “ordinary course of business” requires that the lender or creditor must not give the borrower or debtor more favourable borrowing or indebtedness terms than non-shareholders. Favourable terms include lower interest rate, longer repayment term, less stringent or no credit check, etc.

Repayment within a year is excluded

Where the borrower or debtor repays the loan or debt within one year after the end of the lender’s or creditor’s taxation year in which the loan was provided or the indebtedness was incurred, the loan or debt is not included in the borrower or debtor’s income. As a result, the borrower or debtor will have to amend the return filed in the previous year if:

• The borrower or debtor already included the amount of loan or indebtedness in the previous year’s return, and the loan or debt was repaid in the subsequent year. In that case, the borrower or debtor needs to reduce the income in the previous year by the amount repaid.
• On the other hand, if the borrower or debtor did not include the amount of loan or indebtedness in the previous year’s return and the loan or debt was not repaid in the subsequent year, the borrower or debtor needs to increase the income in the previous year by the amount of the loan or indebtedness.

Apart from the repayment made within one year after the end of the lender’s or creditor’s taxation year, any later repayment is deductible by the borrower in the year the respective repayment is made.

Nevertheless, the repayment shall be deemed not to have been made when the repayment is part of a series of loans or other transactions and repayments. This is the case where the borrower or debtor repays before the end of the lender’s or creditor’s tax year and re-borrows in the new tax year, effectively allowing the shareholder to perpetually defer tax on income received from the corporation.

Certain loans made to shareholder-employees

Besides the above qualifications and exclusions, where the shareholder is also an employee of the corporation, the following loans will be excluded from the shareholder-employee’s income in the year:

• Loan to a shareholder-employee who is not a specified employee. A specified employee is one who deals not at arm’s length with the corporation or who owns, directly or indirectly, at any time in the year, at least 10% of the issued shares of any class of the capital stock of the corporation or of another corporation related to this corporation. In other words, an employee who deals with the corporation at arm’s length and owns less than 10% of the corporation is not a specified employee and thus can exclude the loan from income.
• Loan to acquire a dwelling. The dwelling does not have to be located in Canada and does not have to be the principal residence of the employee. However, the shareholder-employee needs to actually inhabit the dwelling.
• Loan to acquire shares. The CRA does not require a specified length of time that the employee needs to hold the shares of the corporation. However, if the employee disposes of the shares before the loan is repaid, it will raise doubt with the CRA as to the actual intent of the loan.
• Loan to acquire a motor vehicle. The vehicle must be acquired to be used for the office or employment of the employee.

Pro Tax Tip – Shareholder loans or debts are included in income

The taxation rules on shareholder loans and debts are complicated. While generally the loans or debts are included in the income of the shareholder, there are many complex rules on qualifications and exclusions. The qualifications and exclusions are not straightforward and require an examination of the relevant facts. On the other hand, failure to report income from shareholder loans or debts is a taxpayer’s misstatement or omission and may entail serious consequence.

Therefore, taxpayers who receive shareholder loans or debts should consult with experienced Canadian tax lawyers in order to determine how they should report the loans or debts in their income tax returns.

FAQ

The lending corporation gave me a lower interest rate on its loan to me because I am a shareholder. How should I report that?

If the lending corporation gives a shareholder a loan with equally favourable terms as with a non-shareholder, the loan is a normal loan, not a shareholder loan, and thus does not need to be reported in the shareholder’s income in the year. However, a more favourable term, such as a lower interest rate, will make the loan a shareholder loan, not a normal loan, which must be included in the shareholder’s income. Moreover, the shareholder is also deemed to have received a taxable benefit which equals the excess of the prescribed interest over the low interest. These rules intertwine, and the taxpayer is recommended to consult with experienced Canadian tax lawyers.

I genuinely repaid the loan to the corporation in the previous tax year and need to borrow from the corporation again in the new tax year. Can I safely declare the loan as paid in the previous tax year?

The CRA by default will view such repayment as part of a series of loans or other transactions and repayments. Consequently, the loan is not considered repaid and must be included in the borrower’s income. To dispute this default determination, you will have to prove the genuineness of the repayment and the re-borrowing and that the repayment is not sourced from the re-borrowing. You should have experienced Canadian tax lawyers review the transactions and the relevant facts.

 

DISCLAIMER: This article provides broad information. It is only accurate as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on as tax advice. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.