The Canada Revenue Agency comments on back-to-back loan rules

Up until the Canada Revenue Agency (CRA) released comments about back-to-back loan rules, only the Department of Finance (Finance) had commented on how these rules should be applied in situations involving the use of a

corporation’s assets as collateral security for a personal loan to a shareholder.

Finance did make some helpful comments regarding the intent of the provisions, which seemed to limit the scope of when the back-to-back loan rules should apply (see AAMOT Shareholder borrowing using corporate assets as security

– One issue clarified ). But, there was still uncertainty, because Finance agreed that legislative clarification would likely be needed. Would the CRA’s interpretation reflect Finance’s intentions?

The CRA’s comments on the back-to-back loan rules have now been released.

Two interpretations from the CRA have left me feeling not quite warm and fuzzy. Or I should say, I am not feeling

“tantamount” to warm and fuzzy just yet? You’ll see what I mean in a minute….

One CRA technical interpretation (#2017-0690691E5F) considered a situation in which the back-to-back loan rules would apply. Here’s the scenario:

Ms. X is a 50%, limited partner

She funded her investment in the limited partnership jointly with her spouse using a $3 million bank loan

That loan was secured with the bank by the pledge of a $3 million term deposit of Ms. X’s corporation.

Ms. X had an amount outstanding to the bank. The bank held an amount owing to the corporation. The loan was permitted to remain outstanding because the term deposit was outstanding.

The CRA concluded that the back-to-back loan rules applied because the condition in clause 15(2.16)(c)(i) was satisfied. The CRA added that the term deposit might also be a “specified right”.

This seems to be exactly the type of scenario that the back-to-back loan rules were intended to address, since the corporation was the real source of the funds that would have otherwise been loaned to the shareholder directly, were it not for the very punitive shareholder loan rules.

The other CRA technical interpretation (#2017-0703901C6) ostensibly sounds positive, capturing the positive comments from Finance about the intent of the provisions:

“As with the other provisions of these rules, the “specified right” rule in subparagraph 15(2.16)(c)(ii) is generally meant to capture situations in which the corporation itself is the real source of the funding to the shareholder and not the intermediary. As such, where a security interest in the company’s assets is tantamount to putting assets in the hands of the intermediary for its general use, the shareholder loan rules will ordinarily apply. Where, on the other

hand, the security interest is a typical commercial security feature of an arm’s length lending arrangement, such that

the assets that are the subject of the security can only be used to repay the debt and any accrued interest, the

shareholder loan rules should generally not apply.”

The good news continues with the CRA stating, “where a financial institution lends money on commercial terms to an individual that is a shareholder of a corporation, the corporation provides a security interest in its property to the lender, and such property can only be used in the event of default on the loan as a means of repaying amounts owing by the debtor under the lending agreement, then the security interest would not ordinarily be considered a “specified right”. The CRA goes on, “a security interest granted by a corporation to a creditor that may be used, in the event of default, to repay more than one debt owing by a shareholder of the corporation to that creditor would not, in and of itself, be considered a specified right.”

These are all positive-sounding comments. So why am I not feeling warm and fuzzy? It’s the “tantamount” word that’s

getting me.

What is the “real source of the funding,” if something other than a term deposit with the lending institution is pledged for the amount borrowed? What is the “real source of the funding” - the corporation or the intermediary – when a different company asset, such as a term deposit with another financial institution, or the cash value of a life insurance policy, or one of the corporation’s other investment assets, is pledged?

We may need to ask the CRA a more specific question to clarify the fuzziness. February 2018