Achieving temporary relief from tax on CEBA loans
This content originally published on Canadian Tax Foundations newsletter: Canadian Tax Focus. Republished with permission.
To the great dismay of many cash-strapped business owners, the potentially forgivable portion of loans under the Canada Emergency Business Account (CEBA) program is not taxable in the year of forgiveness, but rather in the year of receipt of the loan (pursuant to paragraph 12(1)(x)). (See CRA document no. 2020-0861461E5, Nov. 10, 2020.) Although some have questioned this conclusion on the basis of GMAC Leaseco Corporation (2015 TCC 146), few people are willing to risk CRA pushback for a short-term deferral on a maximum $20,000 income inclusion. There is one ray of hope for this early income inclusion: where an outlay or expense funded by the loan does not occur until a subsequent taxation year, the income inclusion can be deferred until that taxation year by making the subsection 12(2.2) election. Still, the requirement to trace the loan to those future expenditures may convince many taxpayers to avoid the election.
Consider this example. A calendar-year taxpayer receives the maximum $60,000 loan in 2020 and spends all of it on employee wages: $45,000 in 2020 and $15,000 in 2021. Without the election, there would be an inclusion of $20,000 in 2020 for the potentially forgivable amount of the loan, and each of the wage amounts would be deductible in the year incurred in the normal way ($45,000 in 2020 and $15,000 in 2021). With an election in the amount of $15,000 (the amount of the loan received in 2020 but not spent until after the 2020 year-end), the inclusion in 2020 can be reduced from $20,000 to $5,000 (subparagraph 12(1)(x)(vii)). On the other hand, the deduction for wages in 2021 is also reduced by $15,000. Thus, the deferral mechanism has two parts: income in 2020 is reduced, but income in 2021 is increased by an equal amount (by reducing the wage deduction).
The difficulty with the election is administrative—tracing. How does the taxpayer prove to the government that the amount subject to the election was indeed used for a CEBA-eligible outlay or expense after the end of the taxation year? A separate bank account for the CEBA loan provides the best proof, although this is admittedly unrealistic. Taxpayers who are concerned about the possibility of enhanced audit efforts in relation to pandemic-related government funding might wish to forgo the election. Is the short deferral worth the extra compliance effort?
One curiosity about the election is that there can be a permanent reduction of tax—rather than just tax deferral—where there are non-deductible expenses. Inexplicably, such expenses are also eligible for the election (CRA document no. 9721505, Oct. 15, 1997).
Consider this example. The taxpayer again receives the maximum $60,000 CEBA loan in 2020, but spends all of it in that year: $8,000 on non-deductible expenses and the rest on wages. By choosing an election amount of $8,000, and choosing that the expenses or outlays to be reduced by the election are the non-deductible expenses, the taxpayer is able to decrease the paragraph 12(1)(x) income inclusion by $8,000 without any loss of tax deductions. Although the outlays and expenses subject to the election are reduced by $8,000 for the purpose of determining deductions, none of this amount would be deductible anyway.