HELOC Money Lent to Your Corporation: Is the Interest Deductible?

Can I deduct the interest on a HELOC I lend to my corporation?

Interest on a HELOC is deductible when the borrowed money is used to earn income from a business or property and you are legally bound to pay the interest (Income Tax Act, paragraph 20(1)(c)). The test is what the money is used for, and the test looks at its current use (Folio S3-F6-C1, paragraph 1.35). Paragraph 20(1)(c) does not mention what secures the loan, so a loan secured on your home is tested the same way as any other. Money you lend your own corporation is often called a shareholder loan.

A case stops being simple when the credit line also paid for personal things, when the loan has been interest-free for years with interest already claimed, when the loan has no written terms, when interest owed by the corporation has sat unpaid, when the CRA has asked about your line 22100 claim, when you own only part of the corporation, or when you live in Quebec. Each is covered below.

Gather:

• the HELOC statements showing every draw and repayment
• the bank records of each transfer to the corporation
• the loan agreement or a written note of its terms, and the rate charged
• the corporation's records of what it did with the money
• any T5 slips, and any CRA letter about the claim

What if the loan to my corporation is interest-free?

Interest on borrowed money lent interest-free is generally not deductible, because the direct use of the money earns nothing (Folio, paragraph 1.54). The CRA makes an exception for an interest-free loan to a wholly-owned corporation when the loan's proceeds affect that corporation's income-earning capacity (paragraph 1.55). The reasoning is that a corporation that earns more can pay its owners more dividends.

The folio says the answer depends on the facts. These facts bear on it:

• What the corporation did with the money. Money spent running or growing the business bears on its income-earning capacity. Money left idle, or paid back out to you, does not obviously do so.
• Who owns the corporation. The folio's example is a wholly-owned corporation. With several shareholders, its example is each shareholder lending in proportion to their shareholding. A loan from one of several owners falls outside that wording, so the facts decide.
• Whether the loan is on paper. A dated record of the amount, the date and the terms shows what the money was.

Keep these documents. The CRA says to keep all supporting documents in case it asks to see them later (line 22100 page).

If I charge my corporation interest, what rate, and what happens on each side?

A written loan that charges interest gives you interest income and gives the corporation an interest expense. The Income Tax Act sets no fixed rate for it. The corporation's deduction is limited to a reasonable amount (paragraph 20(1)(c)), and a rate set in a market of arm's-length lenders and borrowers is generally reasonable (Folio, paragraph 1.20), so compare your rate with what an unrelated lender would charge the corporation. Interest above a reasonable amount is still income to you, with no matching deduction for the corporation.

The folio also says interest is not denied merely because the income from an investment with a stated rate is less than the interest expense (paragraph 1.69), absent a sham or similar circumstances. That rule for an investment with a stated rate suggests a written rate below your HELOC rate is not a bar by itself; the facts decide. A loan record usually shows the amount and date, the rate, when interest is paid, whether the principal is due on demand or on a schedule, and both signatures.

Unpaid interest

If the corporation deducts interest it never pays you, the unpaid amount can come back into its income after two more years. A corporation and the person who controls it are related, and related persons are treated as not dealing at arm's length, meaning connected rather than independent (section 251). So are the members of a related group that controls the corporation, such as spouses or family co-owners. For other part-owners, whether you deal at arm's length is a question of fact.

If the interest is still unpaid at the end of the second tax year after the year it was incurred, it is added to the corporation's income for the third year after that year. The exception is Form T2047, Agreement in Respect of Unpaid Amounts, signed by the corporation and you. Mail two copies, separately from any tax return, to the corporation's tax centre on or before the date its return for that third year is due. The agreement treats the unpaid interest as paid to you, and lent back to the corporation, on the first day of that year, so interest you have not already reported becomes your income without cash. An agreement filed late still leaves 25% of the amount added to the corporation's income (section 78). If the corporation is wound up within those two years, the unpaid amount is added in the wind-up year.

For interest you pay on money borrowed from the corporation, see interest on a loan from your corporation.

Do I report the interest I receive, and does my corporation issue a slip?

Yes: report interest paid or credited to you on line 12100, even if you did not receive an information slip (CRA line 12100). Interest the corporation has not paid can still be reportable: you include interest accrued to each anniversary day of the loan, not already reported (subsection 12(4)), and the T5 guide says these slips are prepared annually even if the interest was not paid (T5 guide).

The corporation prepares a T5 for interest on money loaned to it, for a recipient resident in Canada, unless the total paid to one recipient for the year is under $50 (CRA: when to prepare a T5). The CRA's line 12100 page notes that you must still report income when no slip is issued because it is below that amount. The T5 shows the interest in box 13, interest from Canadian sources (T5 guide).

The T5 return is due by the last day of February following the calendar year (CRA: T5 due date). The corporation must also give you your copy by then (T5 guide).

Does it matter whether I lend the money or buy shares with it?

Yes: the CRA tests a loan on the income it earns or helps the corporation earn, and tests shares on whether dividends are reasonably expected (Folio).

A capital contribution, money you put in without shares or a repayment date, is treated like an interest-free loan (paragraph 1.56), so the interest-free column applies to it. A loan is recorded differently from shares; see the shareholder loan account.

The line of credit also paid for personal things: how do I split it?

Only the part of the borrowing that you can trace to the corporation qualifies, and the onus is on you to trace it (Folio, paragraph 1.32). Interest on the part spent on a renovation or other personal costs is not deductible.

On a single credit line used for both purposes, each principal repayment reduces the eligible part and the personal part in proportion. You cannot apply a repayment to the personal part first (paragraph 1.43 and Example 10 of the folio). Keeping the borrowed money in its own account makes tracing easier (paragraph 1.34). For tracing a mixed line in detail, see interest on borrowed money to invest or buy a rental.

Where do I claim the interest on my return?

Claim the HELOC interest you paid on line 22100 of your T1, the line for carrying charges, interest expenses and other expenses (CRA line 22100). The folio above decides whether the interest qualifies; line 22100 is where a qualifying amount is claimed.

Report the interest the corporation pays you on line 12100. The corporation deducts the interest it pays you on its T2.

If the CRA asks about your line 22100 claim, it will want the HELOC statements, the transfers to the corporation and the loan terms. Gather those first.

What happens to the deduction when the corporation repays me?

The interest remains deductible only on borrowed money that is still used to earn income, and the current use is what counts (Folio, paragraph 1.35). What you do with the repayment decides the result:

• You pay down the HELOC. The interest falls with the balance, and the deduction falls with it.
• You lend or invest the money again. The interest on that amount is deductible if the new use meets the same tests.
• You spend the money personally. The interest on that amount is no longer deductible. The folio applies the same logic to capital returned on shares (paragraph 1.40).

If the corporation cannot repay and the money is lost, section 20.1 can in some cases treat part of the borrowed money as still used to earn income, so interest on that part stays deductible while it is outstanding. Its conditions are narrow and turn on the facts (section 20.1; Folio, paragraph 1.41).

When you sell your shares, see transferring a shareholder loan to a new owner.

Does Quebec change anything?

Possibly: Quebec administers its own tax laws, and a Quebec resident may have to file a separate Quebec return in addition to the federal one (CRA: Quebec income tax package). The rules above come from the federal Income Tax Act and the CRA's folio on it. Whether Quebec allows the same deduction, and in what amount, depends on Quebec's own rules, which this page does not cover.

Example

These examples are illustrative; all amounts are Canadian dollars.

An interest-free loan

An owner borrows C$80,000 on her HELOC at 6% and lends it to her wholly-owned corporation at 0%. Her interest cost is C$4,800 a year. If the corporation uses the money to run its business, the CRA's exception for a wholly-owned corporation may support her claim. If the money sits idle, the claim is weak. In either case, she keeps the HELOC statements, the transfer records and a note of what the corporation did with the money.

The same loan at 6% in writing

A signed agreement sets the rate at 6%. Each year she reports C$4,800 of interest income on line 12100 and claims C$4,800 on line 22100. The corporation deducts C$4,800 as interest expense, to the extent the rate is reasonable, and files a T5.

Now suppose the loan starts January 1 of Year 1, both use calendar years, and the interest is never paid and does not compound:

• Year 1: The corporation deducts C$4,800 and owes it to her. The loan's first anniversary day is December 31, so she reports the C$4,800 accrued, and the corporation files a T5.
• Year 2 and Year 3: Nothing is paid. Each year she reports another C$4,800 and the corporation deducts it.
• End of Year 3: The Year 1 C$4,800 is still unpaid, so it is added to the corporation's Year 4 income unless both of them file Form T2047 on time. Filing does not make her report that C$4,800 a second time. Each later year's interest runs on its own clock; Year 2's goes to Year 5.

One credit line, two uses

A C$100,000 credit line funds a C$50,000 loan to the corporation at 6% in writing and a C$50,000 kitchen renovation. Half of the borrowing qualifies. She later repays C$10,000 from her own money, leaving C$90,000. Interest on C$45,000, half of the balance, stays deductible. She cannot apply the repayment to the kitchen part.

Different for you?

• The credit line is mixed with personal spending: trace the split using interest on borrowed money to invest or buy a rental. If the split cannot be rebuilt from the statements, get corporate tax help.
• The loan has been interest-free for years and you claimed the interest, or the CRA asked about line 22100: whether earlier claims stand depends on what the corporation did with the money in each year, and a reply to the CRA depends on those records; corporate tax help covers that review.
• You own part of the corporation, only one owner lends, or the credit line is in joint names: the folio's interest-free exception is written for a wholly-owned corporation (or loans in proportion to shareholdings), and the deduction needs a legal obligation to pay the interest, so the facts decide; see corporate tax help.
• You took money out of the corporation: use shareholder loans.
• You borrowed from the corporation and want to charge yourself interest: use interest on a loan from your corporation.
• The loan has no written terms, is missing from the books, or its balance runs the wrong way: use the shareholder loan account, and get bookkeeping help if the records need rebuilding.
• The corporation is new: see books for a new CCPC.
• You are weighing repayment against paying yourself: see how much to pay yourself.
• You live in Quebec: the interest is also a question on your Quebec return; see corporate tax help.
• You live outside Canada: interest paid to a non-resident follows different rules; see non-resident owners of a Canadian corporation.