In this technical interpretation, an interest-bearing demand promissory note was issued in 1987 by an individual as consideration for a loan from his parents. The individual did not make principal or interest payments throughout the term of the loan. The outstanding loan (principal and interest) was repaid in 2007.
The CRA was asked to comment on how the interest income should have been reported for tax purposes.
The CRA’s response
Under the Income Tax Act (the Act), where a debt obligation is considered an investment contract, accrued interest income must be reported by the holder of the contract either triennially or annually to the extent the accrued interest has not already been included in the individual’s income for the year or any preceding year.
For an investment contract acquired after 1989, interest accrued, calculated up to the contract’s anniversary date, must be included in income on an annual basis. Where the investment contract was acquired prior to 1990, the accrued interest must be reported on the anniversary date of the contract at least every third year.
In the given scenario, the individual’s parents received the promissory note in 1987 and, as such, the holders of the note were required to report accrued interest at least every third year (1990, 1993, 1996, 1999, 2002 and 2005), with the balance of the interest income paid and not previously reported in 2007 when the loan was repaid.
The CRA pointed out, however, that if the note was materially altered after 1989, the interest income should have been reported annually. The CRA also noted that where the promissory note is held by both parents, each parent should report their appropriate share of the accrued interest income.
Consequences of not reporting
Where the interest income has not been reported on the required accrual basis, the CRA will assess the applicable income tax together with interest for late payment. In addition, where it is found the taxpayer knowingly or, in circumstances amounting to gross negligence, failed to report the accrued interest, the CRA would apply the gross negligence penalty. In this case, the gross negligence penalty equals 50% of the tax on the unreported amount.
Relief – voluntary disclosure
The voluntary disclosure program (VDP) allows taxpayers to correct inaccurate or incomplete information or to disclose information they have not reported on their tax returns. If the CRA accepts the voluntary disclosure, the taxpayer pays the income taxes owing plus interest, and any penalties are abated. However, the voluntary disclosure provisions in the Act limit the relief to the 10 years preceding the year in which the voluntary disclosure was made.
In the technical interpretation, the CRA commented that the 10-preceding-year limitation of the VDP provisions would not provide any assurances that it would not assess beyond 10 years, and it would decide whether to assess on a case-by-case basis.
Reserve for doubtful debts
In a concluding comment, the CRA noted that where interest income is accrued but not received, a reserve for doubtful debts could be considered. To claim the reserve, the taxpayer must establish that the accrued portion of the unpaid interest is not likely to be paid. However, in a non-arm’s-length situation where payment is eventually made, it would likely be difficult for taxpayers to establish that the reserve is permitted.
When individuals provide interest-bearing loans to “friends and family,” they should be mindful of the resulting obligation to report the accrued interest income for tax purposes.
Failure to do so may result in additional costs for the lenders, which may only be partially subject to relief by the CRA.
CRA video gallery
The CRA has developed a number of videos to deliver information to businesses. These videos cover topics such as payroll, employer-provided gifts and awards, and parking, record-keeping, reporting business income and expenses, how to start a new business, and changes to the Canada Pension Plan.
The videos, accompanied by relevant links and written transcripts, are available at www.cra.gc.ca/videogallery.