Holdco loan to Opco: no 15(2) inclusion when the borrower is Canadian

Does 15(2) apply to a loan between a holdco and an opco?

No, as long as the borrower is a corporation resident in Canada. The opening words of 15(2) exclude that borrower, and a partnership whose members are all corporations resident in Canada laws-lois.justice.gc.ca. The CRA's folio says the same at paragraph 1.21 canada.ca. Subsection 80.4(2) carries the same two exclusions, so no deemed interest benefit arises either laws-lois.justice.gc.ca.

The lender side is wide. Subsection 15(2) reaches a loan from the corporation, from any corporation related to it, or from a partnership that either one is a member of laws-lois.justice.gc.ca. So Opco lending straight to your client is caught even though your client holds shares only in Holdco. The one year repayment window and the series trap for that case are on the shareholder loan page.

What does a $400,000 dividend and loan back cost in tax?

Holdco owns all the shares of Opco, a CCPC with a December 31 year end. Opco has $400,000 of surplus cash it wants out of reach of its trade creditors, $600,000 of safe income on hand that contributes to the gain on its shares, and no RDTOH. Opco pays Holdco a $400,000 cash dividend, and Holdco lends the $400,000 back to Opco, secured on Opco's assets, at 5% a year. The 5% is an assumption for the arithmetic.

Holdco deducts a taxable dividend from a taxable Canadian corporation under 112(1) laws-lois.justice.gc.ca. Holdco controls Opco, so Opco is connected and Part IV is only Holdco's share of Opco's dividend refund, which is nil here laws-lois.justice.gc.ca. Section 55(2) reaches only the part of an intercorporate dividend that exceeds the income earned after 1971 that could reasonably contribute to the gain on the share laws-lois.justice.gc.ca. Pay $700,000 instead and $100,000 is exposed to recharacterization as a capital gain if the purpose test is met. The safe income math is on the section 55(2) page.

The tax rules don't decide whether Holdco's security will hold up against Opco's creditors. That depends on provincial law and on how the security was registered, so it's a question for your client's lawyer.

How is interest between Holdco and Opco taxed?

Interest Opco pays Holdco is turned into active business income in Holdco's hands. Under 129(6), an amount an associated corporation pays that would be income from property for the recipient is, to the extent it is deductible in computing the payer's income from an active business carried on in Canada, kept out of income from property for the investment income rules in 129(4) and treated as active business income for section 125 laws-lois.justice.gc.ca. Holdco and Opco are associated because one controls the other, under 256(1)(a) laws-lois.justice.gc.ca.

The practical result: the interest doesn't build Holdco's RDTOH or attract the refundable tax on investment income, and the $20,000 simply moves from Opco's active business income to Holdco's. The two still share one business limit, so the group pays about the same total corporate tax. The shared limit and the passive income grind are on the holding company page.

Charging no interest is allowed, because no rule imputes interest to a Canadian corporate borrower. If Holdco itself borrowed from a bank to fund that interest free loan, the CRA generally allows Holdco's interest deduction where the loan goes to a wholly owned corporation, or each shareholder lends in proportion to its shareholding, and the money increases the borrower's income earning capacity (folio paragraph 1.55) canada.ca. The general tests are on the interest deductibility page.

Where do upstream loans from Opco to Holdco go wrong?

Routing the cash on to your client. If Opco lends to Holdco and Holdco lends the money on to your client, 15(2.16) and 15(2.17) can deem your client to have borrowed from Opco directly, as the ultimate funder laws-lois.justice.gc.ca. The folio describes these rules as covering debt funding a corporation provides to a borrower indirectly (paragraph 1.18) canada.ca. A Holdco loan to your client is caught by 15(2) on its own anyway, because your client is a shareholder of Holdco.

The lifetime capital gains exemption. A loan to Holdco doesn't take the cash out of Opco: it swaps cash for a receivable that still sits in Opco's balance sheet. For the 90% asset test, a debt counts only if it is owed by a connected corporation that is itself a small business corporation canada.ca. A Holdco full of investments isn't one, so the receivable works against Opco the way the cash did. A dividend to Holdco removes the asset instead. The full test is on the QSBC shares page.

A non resident parent. If the Holdco that borrows is a non resident corporation, 15(2) applies: only a corporation resident in Canada is excluded, and 15(2.2) only switches the rule off when the debt is between two non residents laws-lois.justice.gc.ca. The folio says 214(3)(a) then deems the amount a dividend to the non resident, subject to 25% Part XIII tax unless a treaty lowers it, with a refund under 227(6.1) when the loan is repaid outside a series (paragraphs 1.88 to 1.93) canada.ca. Opco and its controlling non resident parent can instead jointly elect under 15(2.11) to treat the loan as a pertinent loan or indebtedness, filed by Opco's filing due date laws-lois.justice.gc.ca. Then 15(2) doesn't apply, and 17.1 makes Opco include at least interest computed at the prescribed rate, less the interest it already included laws-lois.justice.gc.ca.

What happens if Opco can't repay Holdco?

Holdco gets no allowable business investment loss. Paragraph 39(1)(c)(iv) excludes a debt owed to a corporation by a corporation it doesn't deal with at arm's length laws-lois.justice.gc.ca. Holdco controls Opco, so its bad loan is at best an ordinary capital loss, usable only against taxable capital gains. An individual who lent to their own CCPC is in a better spot; see the ABIL page.

Even that capital loss needs two things. First, Holdco elects under 50(1) once the debt is established to have become a bad debt in the year, which deems a disposition at the year end for nil proceeds and a reacquisition at nil cost laws-lois.justice.gc.ca. Second, 40(2)(g)(ii) sets the loss on a debt at nil unless the debt was acquired to earn income from a business or property, or as consideration for selling capital property to an arm's length person laws-lois.justice.gc.ca. For an interest free loan, keep the file showing why Holdco made it.