Harsh New Rules For Employee And Shareholder Loans

Abstract

Abstract This month, "Tax Topics" examines the changes proposed in the November 12, 1981 federal budget relating to the taxation of stock purchase and housing loans. The changes, if enacted, will come into effect in 1982 to tax the benefits derived from low-interest and interest-free loans. As a result of public pressure, some transitional rules have been announced since the budget date to phase-in the new rules. Introduction Since November 12, 1981, whim Finance Minister Allan MacEachen introduced his proposed sweeping tax changes, there has been a public outcry at the breadth of tax changes and the lack of public discussions preceding the budget. In addition, the original budget was notable in its lack of transitional rules regarding the implementation of many important changes. The proposed taxation of stock purchase loans and honsing loans is one of the few areas that, due to the furor created, has seen some substantive changes since November 12, 1981. However, the draft legislation is not expected until April or May of this year. so it is quite conceivable that the rules may change yet. Many taxpayers associated with the oil and gas industry will be particularly hard hit by these proposals, because of the relatively widespread use of interest-free loans in the industry. For junior oil com panies needing maximum amounts of cash resources to finance exploration and development, the use of interest-free loans to enable employees to acquire company shares has been an attractive compensation device. As the accompanying examples illustrate, although Mr. MacEachen has lowered the top personal income tax rates, the additional amounts that will be included in taxable income can create a greater tax liability. The New Rules According to the budget proposals beginning in 1982, employees and shareholders will be fully taxed on benefits derived from certain loans and other forms of indebtedness. The benefits will be determined by deducting actual interest paid, if any, in the year and within 30 days of the end of the year from imputed interest to be calculated at prescribed rates. The prescribed rate, in future, will be adjusted every three months in relation to the average interest rate on 90-day treasury bills during the first month of the preceding quarter. Although it was orginally announced that the prescribed rate for the first quarter of 1982 would be set at 19%, because of a decline in interest rates since the budget, the prescribed rate was subsequently reduced to 16% for this quarter. Although a loan bearing interest at a rate below the prescribed rate will usually give rise to a taxable benefit, there will be no income inclusion unless the rate charged is also below the prevailing rate available in financial markets at the time the loan was made. The proposed new rules will generally apply to all loans and indebtedness regardless of whether issued before or after the November budget date.