Jul 31, 2025
Income Tax Folio S3-F1-C2, Deemed Interest Benefit on Shareholder Loans and Debts, replaces and cancels Interpretation Bulletin IT-421R2
In April 2025, the Canada Revenue Agency (CRA) issued the Income Tax Folio S3-F1-C2, Deemed Interest Benefit on Shareholder Loans and Debts, which can be relied upon as the accurate summary of the CRA’s interpretation (which is not necessarily correct) regarding subsection 80.4(2) and related provisions in the Income Tax Act (ITA) regarding shareholder loans and debt.
This Folio replaced and cancelled the long-standing Interpretation Bulletin IT‑421R2, Benefits to individuals, corporations and shareholders from loans or debt, which was issued back in 1992 and last updated in 1995.
Loan or debt by virtue of shareholding
In a nutshell, subsection 80.4(2) generally deems a person who receives a loan or incurs a debt at a low interest rate or no interest at all from a corporation by virtue of shareholding to have received a taxable benefit.
The amount of the deemed interest benefit is the amount of interest payable at the prescribed rate of interest in excess of the interest paid in the year or within 30 days thereafter. The deemed interest benefit must be included in income for the tax year. However, there are a number of qualifications and exceptions which will be discussed further below.
Subsection 80.4(2) intends to cast a wide net to capture the scenarios that are not limited to where the corporation directly gives money to its shareholder, but also include where the loan is provided or the indebtedness is incurred due to the shareholding of related parties.
The person who receives a loan or incurs a debt is the borrower or debtor, and the corporation is the lender or creditor. A loan is where the lender gives money directly to the borrower, and debt is where the creditor makes a payment to a third party on behalf of the debtor or advances a future payment, such as salary or dividend, to the debtor.
The borrower or debtor is not limited to the shareholder of the corporation but can also be someone who does not deal at arm’s length with the shareholder such as (i) a spouse or a common-law partner of the shareholder, or (ii) a member of a partnership, or a beneficiary of a trust, that was a shareholder of the corporation. However, a corporation resident in Canada or a partnership whose members are corporations resident in Canada is excluded, meaning the loan or debt is not classified as shareholder loan or debt.
The lender or creditor is not limited to the corporation of which the borrower or debtor is a shareholder but can also be (i) related to another corporation of which the borrower or debtor is a shareholder, or (ii) a partnership of which the corporation that the borrower or debtor is a shareholder is a member.
Prescribed rate of interest
The prescribed rate of interest is the crucial element because subsection 80.4(2) only applies where the loan or debt is made at an interest rate lower than the prescribed rate of interest (or no interest at all).
The prescribed rate of interest is updated by the CRA on a quarterly basis. As of the third quarter of 2025, the rate used to calculate taxable benefits for shareholders and employees from low-interest or interest-free loans is 3%.
It means that a loan or debt made by a corporation to its shareholders at the prescribed rate of interest or higher, also known as an arm’s length rate, will not be subject to the deemed interest benefit provision in subsection 80.4(2).
No deemed interest benefit for loans or debts already included in income
The deemed interest benefit rule in subsection 80.4(2) functions in tandem with the shareholder loans and debts rule in subsection 15(2). While the deemed interest benefit applies to shareholder loans and debts, where the shareholder loan or debt is already included in the borrower or debtor’s income of the year by virtue of subsection 15(2), there will be no deemed interest benefit.
For example, when a shareholder loan or debt at a low interest rate, or interest-free, is made and the borrower or debtor already includes the loan or debt in his or her income for the year under subsection 15(2), the borrower or debtor need not be concerned with the deemed interest benefit in that year.
If the borrower or debtor repays a portion of the loan or debt in the next year, the exception to subsection 15(2) applies to the repaid portion; the borrower or debtor needs to amend the tax return for the previous year, removing the repaid portion of the loan or debt from income and adding the deemed interest benefit on that portion into income.
That would result in a reduced tax liability for the previous year, and the borrower or debtor would receive a tax refund, plus interest, as a result. The borrower or debtor also needs to include the deemed interest benefit for the part of the year when the repaid portion of the loan or debt is outstanding. As for the outstanding portion of the loan or debt, as it is still included in the income of the previous year, there is no deemed benefit interest on that portion.
On the other hand, when the shareholder loan or debt at a low interest rate or interest-free is made and the borrower or debtor does not include the loan or debt in his or her income for the year (in anticipation that the loan or debt will be repaid within the next year), the borrower or debtor will have to include the deemed interest benefit in that year.
If the borrower or debtor however does not fully repay the loan or debt in the next year, the exception to subsection 15(2) does not apply to the unpaid portion; the borrower or debtor needs to amend the tax return for the previous year, adding the unpaid portion of the loan or debt into income and removing the deemed interest benefit for that portion from income.
That would result in an increased tax liability for the previous year, and the borrower or debtor would have to pay tax, plus interest, as a result. Since the outstanding portion of the loan or debt is now included in the income of the previous year, the borrower or debtor need not be concerned with the deemed interest benefit.
Forgiven loan or debt does not affect the deemed interest benefit in the previous years
When the shareholder loan or debt, or a portion thereof, is forgiven, the forgiven portion is a taxable benefit to be included in the borrower or debtor’s income for the year the forgiveness occurs. However, it does not affect the inclusion of the deemed interest benefit in the years prior to the year the forgiveness occurs.
Pro Tax Tip – Deemed interest benefit is included in income
The rules on shareholder loans and debts, and deemed interest benefit, are complicated. Generally, when the shareholder loan or debt is made at interest-free or an interest rate lower than the prescribed rate of interest, the excess of the interest calculated at the prescribed rate of interest over the interest paid in the year shall be included in income.
However, the rule on the inclusion of the shareholder loans and debts takes precedence over the rule of deemed interest benefit. The taxpayer must determine in each case whether the loan or debt should be included in income or whether it is the deemed interest benefit that needs to be included.
Failure to report income is a taxpayer’s misstatement or omission and may entail serious consequences. Therefore, taxpayers who receive shareholder loans or debts should consult with experienced Canadian tax lawyers in order to determine how they can report the loans or debts properly in their income tax returns.
FAQ
As a shareholder, I received a loan at a 2% interest rate from the corporation. Is there a deemed interest benefit?
The prescribed interest rate, at the time the loan was taken out, is the benchmark as to whether an interest benefit has been conferred on the shareholder.
For instance, as of Q3 2025, the prescribed rate of interest is 3%. If the shareholder loan was taken out in Q3 2025 and the applicable interest rate is 2%, then there is indeed a deemed interest benefit. You may have to include the benefit in the year’s income.
As a shareholder, I received an interest-free loan from the corporation. Should I include the loan as well as the interest benefit in my income?
No, the shareholder loans and debts inclusion rule and the deemed interest benefit rule work together, but do not operate at the same time. The shareholder loans and debts inclusion rule takes precedence.
Under that rule, if it is determined that the loan or debt must be included in income, no interest benefit entails. On the other hand, if the loan or debt is not to be included, then the interest benefit is deemed to have been received and taxable. These rules are complex, so taxpayers should consult with experienced Canadian tax lawyers.
DISCLAIMER: This article provides broad information. It is only accurate as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on as tax advice. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.
