New CRA Ruling on Making Loans to Foundations
By Alexandra Tzannidakis, LL.B.
In July of this year, the CRA issued a ruling around making loans to charitable foundations. The ruling was requested by a taxable corporation that had set up its own foundation, a registered charity. The corporation wanted to know what the tax consequence would be for advancing interest-free money to the foundation. This is a common situation, so the CRA’s comments should be of particular interest to the business and charitable sectors alike.
In its ruling, the CRA confirmed that a debt obligation with no stipulated rate of interest falls within section 12(9) of the Income Tax Act, meaning that the corporation might be required to accrue interest on the loan. In general, this deemed accrual will only occur if the cost of the loan is less than the amount payable at maturity. If, on the other hand, the cost is equal to the amount payable at maturity, there will be no interest deemed to accrue.
However, the situation is complicated by the fact that the corporation and the foundation are not at arm’s length from each other. When a loan is made between two related entities, and the loan is not repayable at the lender’s demand, the ‘cost’ to the lender of making the loan may be reduced. If the fair market value of the loan is less than the amount advanced under the loan, the corporation may be deemed to have acquired the loan at a cost equal to the fair market value of the loan. This would result in deemed accrual of interest, as described above. Reducing the cost of the loan would also affect the calculation of the corporation’s eventual gain or loss on disposition of the loan.
When engaging in financial transactions with related non-taxable entities, corporations should be aware that there are complex tax-planning aspects specific to their situation of which they should take close account.