Shareholders should be aware of corporate shareholder benefits and subsection 15(1) of the Income Tax Act (ITA). When the CRA audits a private corporation, it uses subsection 15(1) to ensure transactions are properly recorded. Subsection 15(1) states that where a corporation has conferred a benefit on a shareholder, the value of that benefit will be included as income to that shareholder. The amount of the benefit is taxed as regular income to the shareholder. The section is exceptionally broad and may capture a wide range of situations. Shareholders oftentimes unintentionally and innocently find themselves taxed with shareholder benefits.
The issue primarily arises from improperly recorded transactions. The shareholder loan account can be a source of this problem, because it is not as well documented as salary or dividends paid to a shareholder.
In addition, it may be difficult to ensure there is a clear divide between personal and corporate accounts and expenses in a private corporation. If a personal expense is paid by the corporation, for example, it must be treated as a payment to a shareholder. The personal expense is not deductible by the company. If the transaction is not properly recorded, then CRA can use subsection 15(1) to ensure taxes are paid accordingly.
As another example, if a corporate asset is transferred to a shareholder or his or her family member, then care must be taken to ensure the transaction is recorded as occurring at the fair market value of the asset, as assessed at the time of the transfer. If the asset is recorded at a price under the fair market value or not recorded at all, then subsection 15(1) will come into play.
To further understand this provision, it may be instructive to break the provision down into three parts. There must be a “shareholder”, there must be a “benefit” to that shareholder and the “value” of that benefit will be taxed to the shareholder.
First, the section applies to a “shareholder”. This term is defined as a person (individual or corporation) who is entitled to receive payment of a dividend from the corporation, and extends to individuals not dealing at arm’s length with the shareholder (such as a family member).
Second, the term “benefit” is not defined in the ITA. The term has been used broadly and shareholders must be aware of its far reach. It can include many items, such as insufficient consideration for corporate assets, personal use of corporate assets, and payment of personal expenses through corporate funds. It may also include the use of corporate funds to purchase shares of the corporation, as well as to purchase a golf membership not used solely for promoting the corporation. As illustrated by these examples, it is a far-reaching provision.
Determining the value of the benefit is oftentimes not formulaic. The CRA will determine its fair market value, which can be difficult to determine and may vary between assessments. The CRA may determine that the fair market value of a certain asset is much higher than a shareholder’s assessment of its fair market value. Courts have also used the “return on investment” approach to determine the value of the benefit when the fair market value assessment is not sufficient.
As mentioned above, if a transaction is caught under this section, then the amount of the benefit is taxed to the shareholder at his or her marginal tax rate. In addition, there is no deduction to the corporation for the benefit. This can result in a significant tax cost to the shareholder and corporation.
To steer clear from subsection 15(1), shareholders should, among other things, ensure they have proper documentation to support the fair market value assessment of certain benefits, diligently record all transactions, and maintain a clear divide between personal and corporate expenses and accounts.
If you have any questions with regard to shareholder benefits and corporate transactions, feel free to contact Conduct Law. Conduct Law is an Ottawa based business law firm with locations in Ottawa, Barrhaven and Kanata. Our professionals are experienced business lawyers who can help with commercial real estate, liens, incorporations, trademarking or implementing corporate structures that manage tax obligations, whether as a corporation, partnership, family trust, testamentary trust, or any other type of legal entity.
Feel free to call or write one of our professionals at firstname.lastname@example.org or 613.440.4888 for all of your business, commercial, real estate and estate planning needs.