Indirect tax pain

CRA dings shareholder for relative’s benefits

It may be quite tempting as a small business owner to pay various personal expenses out of your corporation’s income. Needless to say, such expenses would not be tax deductible unless incurred for legitimate purposes to earn business income. In addition, depending on who receives them, an employee or shareholder benefit can also be assessed by the Canada Revenue Agency.

This past summer, the CRA was asked whether a company could legitimately pay for the university tuition and living expenses of a company shareholder’s relative who was neither an employee nor shareholder of the corporation.

The Income Tax Act states that no expense is deductible in computing a corporation’s business income unless it was incurred for the purpose of earning income. The Act further denies the deduction of any personal or living expenses. The CRA responded that, based on its understanding of the facts, the amounts paid by the corporation to the shareholder’s relative were “personal or living expenses and have not been incurred by the corporation for the purpose of gaining or producing income.” As a result, the expenses associated with paying the relative’s tuition and living expenses would not be deductible.

But paying the expenses of a relative has even worse implications for the shareholder because of shareholder benefit rules. Under these rules, if a benefit, such as free tuition, is conferred by a corporation on a shareholder, then the amount or value of that benefit must be included in the shareholder’s taxable income for the year, with only a few, very narrow exceptions. In this situation, the benefit was conferred not on the corporation’s shareholder, but on his relative. Nonetheless, the indirect payment rule comes into effect, which would still consider the shareholder to have received a taxable benefit equal to the amount of the tuition or living expenses received by his relative.

Note that the rules are quite different when an arm’s length employer provides a post-secondary scholarship, bursary or free tuition to family members of an employee under a scholarship program. In such a situation, the amount can generally be received by the student as a tax-exempt scholarship. To get this tax result, however, there must be “objective selection criteria that focus on the accomplishments of the... child of the employee/minor shareholder (and) the scholarship program would need to available to children of all employees, not just the children of key employees/shareholders.”