The Income Tax Regulations prescribes (and the CRA publishes) various interest rates which impact Canadian taxpayers in different ways. This article sets out what each of these prescribed rates are and how the increase may impact Canadian taxpayers' decision-making.
Overview of the Rates
There are four main categories of these prescribed rates, those:
- charged on overdue taxes, Canada Pension Plan Contributions and employment insurance premiums (the "Overdue Rate");
- paid by the CRA on taxpayer overpayments (collectively the "Overpayment Rates");
- used to calculate taxable benefits on related party loans (the "Benefit Rate"); and
- used to calculate corporate taxpayers' pertinent loans or indebtedness (the "Pertinent Rate").
All of these rates are calculated based on average annualized yields of Government of Canada 3-month treasury bills sold during the previous quarter. As interest rates have gone up, so have treasury bill rates, which has caused the prescribed rates to increase. This marks the third consecutive quarter of increase.
The current rates apply from January 1, 2023 to March 31, 2023. It appears likely the rates will increase again for the next quarter, commencing April 1, 2023.1 Each of these rates is described in detail below.
The Overdue Rate
The Overdue Rate is unsurprisingly the highest interest rate, currently at 8% (having gone up from 5% over the last 3 quarters). So, if an individual or corporate entity is late on payments to the CRA, they will owe interest at 8% until fully paid.
Further, this interest is compounded daily starting the balance due date meaning a taxpayer pays significant interest on interest, not merely the outstanding debt multiplied by 108%. This makes it more important than ever that taxpayers remit their payments on time.
The Overpayment Rates
On the other hand, if the CRA owes money to taxpayers on overpayments, the applicable interest rate is much lower. The Overpayment Rates on amounts owed to corporate and non-corporate taxpayers are now 4% and 6% respectively (in the second quarter of 2022 they were 1% and 3%).
The increase in these rates is beneficial to taxpayers as they will receive more interest from the CRA. This interest also compounds daily, however, for corporations this starts the later of 120 days after the end of the year or 30 days after the return is filed. For individuals, it is the later of 30 days after the return is due or filed. This effectively gives the CRA 30 days to pay a tax refund without interest.
The Benefit Rate
In certain circumstances, the Income Tax Act will deem there to be a taxable benefit on related party low interest or no interest loans such that interest is deemed to apply at the Benefit Rate. This most commonly arises on a loan from a company to a shareholder, or employer to an employee. The current Benefit Rate is 4% (in the second quarter of 2022 it was 1%). This amount is not compounded.
When the Benefit Rate was just 1% between July 1, 2020 and June 30, 2022, the imputed interest was fairly insignificant to the borrower. The increase to 4% means the imputed interest is now more than nominal and these types of loans may no longer make sense for the borrower.
The 4% Benefit Rate also applies to prescribed rate loans ("PRLs") between family members which would otherwise be subject to attribution rules. Typically when a person (the "lender") gives or loans funds on a low or no interest basis to their spouse or to a non-arm's length minor child (including a niece or nephew) any investment income earned on those funds is attributed back to the lender for tax purposes.
If, however, a PRL is used, the income on the funds will be taxed in the hands of the recipient. To qualify as a PRL, the following must be present/occur:
- A written loan agreement;
- An interest rate equal to, at a minimum, the Benefit Rate prescribed at the time the loan was made; and
- Interest payments for any given year must be paid by January 30 of the following year.
The minimum interest rate applicable is the Benefit Rate in effect at the time the loan was initially made. Thus, individuals who initiated PRLs between July 1, 2020 and June 30, 2022 can continue to take advantage of the 1% rate so long as they continue to comply with the above requirements. This makes it more important than ever that interest payments be made on time.
Further, with the prescribed Benefit Rate likely increasing to 5% in the second quarter of 2023, if someone is planning a new PRL, it should be entered into now to take advantage of the 4% rate.
If the Benefit Rate falls, the 4% rate will continue to apply to the existing loan. To take advantage of the lower rate, the loan would need to be repaid and a new loan created. Note that simply refinancing or repaying the previous loan with the new loan may result in the attribution rules applying.2 Instead, enough investments to satisfy repayment of the original loan should be sold before the new loan is provided.
The Pertinent Rate
Where a corporation resident in Canada (a "CRIC") is owed money by a non-resident of Canada, section 15(2) or 212.3 of the ITA may apply to deem that amount as having been paid to the debtor as a dividend. As a deemed dividend, the amount is subject to the non-resident withholding tax.
Both section 15(2) and section 212.3 contain an election whereby the amount owing is treated as a "pertinent loan or indebtedness" instead of as a dividend, avoiding the withholding tax. Deemed interest would apply to the pertinent loan or indebtedness at the greater of:
- interest calculated at the Pertinent Rate; or
- where the loan is funded directly or indirectly by another loan owed by the CRIC (or certain non-arm's length persons or partnerships), the amount of interest payable on that loan, less any interest already included in the income of the Canadian resident corporation.
The Pertinent Rate is now 8% (in the second quarter of 2022 it was 4.38%). The increased Pertinent Rate makes this treatment less advantageous for Canadian taxpayers as interest income imputed to the CRIC will increase.
Key Takeaways
The increased Overdue Rate makes it more important than ever that taxpayers remit their payments to the CRA on time. Interest on late payments is now a much more significant cost to taxpayers. The increased Overpayment Rate on the other hand benefits Canadian taxpayers as interest paid by the CRA on overpayments will increase, though the CRA is pretty good at limiting their own interest payable.
The increased Benefit and Pertinent Rates will lead to increased imputed income in certain loan situations. This makes no or low interest loans less desirable as the borrower (for the Benefit Rate) and the lender (for the Pertinent Rate) will see a real impact on their taxes from the imputed income. As the rates increase, the audit risk also increases as the CRA stands to benefit more from discovering a failure to impute the required amounts.
Lastly, existing PRLs should be carefully maintained so that the advantage of the previously low Benefit Rate is not lost. New prescribed rate loans should be created prior to April 1, before the Benefit Rate increases again.
Footnotes
1. Based on 3-month treasury bills sold at auction in January 2023.
2. CRA technical interpretation 2002-0143985.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
